Loan Reserves

Business Funds and other deal killers

What are reserves and why do they play such an important part in whether you get approved for a mortgage loan?  Reserves are the funds that a borrower has at their disposal after the down payment and closing costs have been payed (basically the money the borrower has in the bank after closing).  

On a conventional loan, a lender will typically want to see that a borrower has 2 months reserves in the bank after the loan closes.  If a borrower is wanting to purchase a home prior to selling the home they currently live in, the lender will typically want to see that the borrower has 6 months reserves on both properties.  1 month of reserves is the equivalent of the monthly principal, interest, taxes, and insurance or PITI.  So what will the lender count toward meeting the reserve requirement?

Money in a personal checking or savings account (if properly sourced) will count.  Certificates of deposits (CD'S), stocks, bonds, life insurance policies (the cash value of the policy), 401k accounts (the vested balance), and IRA accounts will typically count.  Foreign assets will also typically count.  Gifts from a relative, domestic partner, fiancé/fiancée can also typically be used to satisfy the down payment and or reserve requirement.  Money from an inheritance (once received) will typically count.

Here are some things you might think would count as reserves that might not like funds in a business account.  While funds from a business (Sole Proprietorship, Partnership, Corporation or S-Corporation) technically can be used to satisfy the down payment, closing costs and reserve requirement, what a lender will put the borrower through (the ringer) in order to use these funds may not make these funds worth using if they are allowed by the lender.  When making the decision on whether business funds will be allowed, an Underwriter will carefully scrutinize the business looking for things like the borrower's percentage of ownership in the business and whether or not using these funds may have a negative impact on the operations of the business.  If there is any indication that using the funds from the business account could negatively impact the business, then the funds might not be allowed.  Another hoop to jump through regarding the use of business funds would be that at least a 5% cash investment will typically still be required from the borrower's personal assets unless the business is a Sole Proprietorship. 

Another thing to consider regarding the use of business funds is that the Underwriting process will not be a quick and easy process.  Also, the amount of documentation that will be required by the lender can often be agonizing.  As the borrower, make sure that you set the proper expectations up front with the seller (BEFORE GOING UNDER CONTRACT) that you might need a little more time to close than normal.  Most of the time a seller will extend the closing date to allow the borrower more time to close although they are not required to do this.  If the seller has a back-up offer on the home (especially if the offer is higher) they may very well cancel your contract because you were not able to close on time.

If you do have funds in a business account that you were planning on using toward a home purchase, you may want to consider moving those funds to a personal account.  Once those funds have been in a personal account for 60 days they are considered seasoned funds and the lender cannot ask where they came from as no paper trail has to be provided.

Other sources that typically won't be counted would be a home equity line of credit (amount available on the credit line) or equity in an existing property.  While a home equity line of credit can be used for the down payment it won't be counted toward meeting the reserve requirement.

Today's lending environment provides a few more challenges and pitfalls than the lending environment of a few years ago.  As a borrower, make sure that you ask your lender the right questions regarding what you are going to need to ensure the transaction goes through quickly and seamlessly BEFORE signing on the dotted line with the seller.  Take the proper steps prior to going under contract to minimize your risk, stress and frustration.