Retirement Funds as Mortgage Reserves

Retirement Reserves Mortgage Approval

Retirement Reserves Mortgage Approval

Reserves (while not required on all mortgage types) are a key piece of many Arizona mortgage approvals.  Borrowers are allowed to count retirement assets as reserves however there are a few very important restrictions that govern how much of the account balance can be used (see below for more).  Not knowing these restrictions can cause HUGE problems and even result in a home loan application being declined.

What are “RESERVES?”

Typically when a buyer is purchasing an Arizona rental home or a vacation home they are required to have a specific amount of money left over after they have paid for closing costs and down payment.  These “left over” funds are known as RESERVES.  The amount of reserves required differs from transaction to transaction however the core regulations that dictate what amount of funds from what types of financial accounts can count toward reserves are the same.

Can You Count Retirement Funds as Reserves?

The answer is yes.  You can count Retirement funds as reserves.  Okay, the much more accurate answer is that you can count some retirement funds as reserves in certain cases (yep – here come the “ifs” “thens” and “buts”).  When evaluating a whether or not a client can use retirement funds as reserves an Arizona loan officer MUST dig a couple of layers below the surface to MAKE SURE that an underwriter will allow the funds to be counted toward the reserve requirement.

2 important reserve requirements:

1. Lender can only count 60% of the clients vested balance toward reserves
2. Lender can only count retirement funds as reserves if the 401k and/or IRA allows withdraws for emergencies related to the type of property being purchased OR that the borrower already owns (see below for more)

Number 1 is easy.  For every $1,000 a client has vested in a retirement account a lender can count $600 toward reserves.  Number 2, well that gets a little more complicated.  Follow me into the rabbit hole!

The purpose of a reserve requirement is to make sure that the buyer has enough money left over to cover any costs related to both the property being purchased and properties that the client already owns.  More specifically, reserve funds must be funds that a borrower can actually access if and when they do need to dip into their savings to cover emergency costs related to their real estate.  Makes sense right?  Funds that the borrower cannot easily access should not count toward reserves based on the fact that the borrower does not really have easy quick access to those funds to help put out a financial fire associated with real estate related costs.

Determining if Retirement Funds are Accessible

Determining whether or not retirement funds are accessible is a key step in determining whether or not a Phoenix mortgage company will count retirement account funds as reserves.  Each and every 401k/IRA account comes with a set of predetermined rules regulated by both their account servicer and (more importantly) their employer.  These rules are outlined in a document called either a “plan summary” or the “terms and conditions” of the account.  This is where the real magic happens (and where many loan officers miss an important piece of the reserves puzzle).

The terms and conditions or plan summary will state whether a client can withdraw funds for an emergency.  They will also state what property/occupancy types retirement funds can be withdrawn for.  For example, a 401k or IRA will often allow a client to withdraw funds for any financial emergency related to a primary residence.   They typically will not allow funds to be withdrawn for financial emergencies related to an investment property.  This means that the funds in a 401k or IRA with this type of “rule” could be counted toward the reserve requirement related to a primary residence. However, in this case funds should NOT be counted toward the reserve requirement related to an investment property.  Lets’ look at an example.

Reserves calculation example

Buyer Name: Frank

Scenario: Frank is purchasing a new investment property

Guideline:  Lets assume this particular case requires 6 months reserves (that means the borrower would need to have funds left over in liquid accounts after closing that equal 6 x’s the mortgage payment on his primary residence plus 6 x’s the mortgage payment on the rental property he is purchasing

  • Frank’s Mortgage Payment on current primary residence: $1,500
  • Reserves required for primary: $1,500 x’s 6 = $9,000
  • Frank’s Mortgage Payment on new rental property: $1,000
  • Reserves required for rental property:  $1,000 x’s 6 = $6,000

Franks Asset Balances:

  • Checking/Savings:  $3,000
  • 401k:  $20,000

*401k allows for withdraws related to emergencies on primary residences only

Does Frank have enough in reserves to meet guidelines and therefore qualify for the loan?  If so you said “NO” you were right and here is why:

Frank’s 401k account is only worth $12,000 when it comes to counting it toward reserves ($20,000 x 60% = $12,000 – see top of article for reason).   This retirement account can also only be counted toward reserves for the primary residence (this is extremely important to note).   Since the primary residence reserve requirement is $9,000 – $9,000 from the $12,000 401k funds would go toward and satisfy the $9,000 primary residence reserve requirement leaving $3,000 in funds from the 401k and $3,000 in the checking/savings.

If we apply Frank’s checking/savings balance 0f $3,000 toward the $6,000 needed in rental property reserves we come up $3,000 short of the total reserve requirement for the rental property.  This is true even though there are still $3,000 left over from Frank’s 401k.  The $3,000 CANNOT be counted toward the rental property reserve requirement because in this hypothetical example (as is the case in most real life scenarios) the 401k terms and conditions only allow a withdraw of funds for emergencies related to primary residences NOT rental properties.

At first glance Frank had enough money to satisfy the 6 month reserve requirement for both of his properties.  He had a total reserve requirement of $15,000.  Between his checking/savings and 401k accounts Frank had a total of  $15,000 (after netting the 401k down by 60%). However, after a detailed and thorough analysis of Frank’s 401k terms and conditions we found out he can only apply funds from the 401k to the primary reserve requirement. There is not enough money in Frank’s checking/savings to satisfy the rest of what is needed in reserves. Frank’s loan application would ultimately be declined in underwriting.  Best to catch this in the pre-approval stage.  To those who groan and complain about providing documents to your lender for a pre-approval – this is just one of many reasons why to do like Nike  says and “just do it”.

Underwriting WILL Dissect Retirement Assets

When it comes to issuing a pre-approval your Arizona mortgage loan officer needs to be as good if not better than an underwriter in terms of product knowledge.  An underwriter will NOT miss any detail when it comes to analyzing a borrowers retirement accounts when determining if a borrower can use retirement assets as reserves.  Underwriting and asset analysis is a multi-layered process.  When an Arizona mortgage loan officer only completes step 1 it winds up costing you in the end.  If a mortgage underwriter invented country dancing you would have never heard of the 2-step.  Cowboys and cowgirls everywhere would be dancing the 8-step!

Call: 602.435.2149

By Jeremy House


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