How to Use Retirement Funds as Mortgage Reserves

Qualifying for a mortgage often means more than making enough money every month to cover the mortgage payment. Many lenders require you to have mortgage reserves on hand. This is money you have available in case your income decreases or stops suddenly. It helps you continue to make your mortgage payments on time.

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The trick, however, is what lenders allow as reserves. They are typically funds you have on hand in a liquid account or funds you can receive if you sell an asset you own. The lender counts reserves based on the number of months of mortgage payments it can cover immediately. So how do retirement funds fit in? We take a look below.

The Requirements for Retirement Funds

Retirement funds are an asset; however, they have unique circumstances. You must be able to withdraw that at a moment’s notice. In other words, you may only count the funds that are fully vested. If you have a 401K account and your employer matches some of your contributions, you may not be fully vested. You must prove that the money in your account is 100% yours. You can do this with your employer’s handbook or documents from the investment company.

The funds that you can use, however, will not be counted at 100%. Let’s say you have $100,000 in a retirement account. The lender will not qualify you based on $100,000 in assets. Instead, they will likely use 60% of the fully vested balance. If your $100,000 was fully vested, the lender would use $60,000 for qualifying.

One last requirement, however, is proof from the investment company that withdrawals are allowed. You will not be using the funds to buy a home or to use during retirement. Because these are special circumstances, the lender will need to see that you are able to use the funds for this purpose. You can prove the availability of the funds for this purpose with your Plan Summary. Reading the fine print will let the lender know if you can use the funds in the face of an emergency.

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Proving the Reserves

The next step is proving the amount of reserves you have in your retirement account. Usually, you can provide your latest investment statement from the broker. This should show the current value of the account as well as the amount that is fully vested. It should also, however, show the amount that is available for immediate withdrawal, should the need arise.

What do Reserves Do?

Aside from the fact that reserves help bail you out should you not be able to pay your mortgage, they also serve as a compensating factor.

Let’s say you are applying for a conventional loan. You have a 680 credit score and a 29/37 debt ratio. You have stable employment and your income has steadily increased over the last few years. However, because you are at the cusp of the guidelines with a lower credit score and higher debt ratio, you are a risk. Some lenders would turn you down. Others may consider you if you have compensating factors.

Compensating factors are things that set your application apart from others. It shows the lender that you have other factors that ‘make up’ for your riskiness. In this case, reserves make up for the riskiness. If you have funds that can serve as a backup should you get in a financial bind, it makes the lender feel better about your ability to pay the mortgage.

Your retirement funds can be that compensating factor as long as they are available for immediate withdrawal. Again, only the fully vested funds are available as a qualifying factor. Any funds that you lose if you leave your job are not used for qualifying purposes.

Of course, you shouldn’t rely on your retirement funds as your reserves. It’s best if you have funds in savings, mutual funds, or other liquid investments. It’s also best if you have a low debt ratio and great credit score. But, of course, if you have the retirement funds, you can make use of them as a qualifying factor. It doesn’t mean you have to dip into them and risk your financial freedom in retirement. It’s just a safeguard against an emergency.

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Justin McHood is a managing partner at Suited Connector and has been recognized by national media outlets as a financial expert for more than a decade.

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