How much cash to keep in reserve?

Question

Hello all,

We are just staring out, closed on our first rental property in January and waiting to close the second.  Our plan for the the first year was to purchase two cashflowing properties, then use the cashflow from those and anything else we can scrape together (income we don't spend and toys and equipment we can sell) to make purchase #3 in year 2.  With interest rates this low and property prices rising in our area, we are anxious to move on to #3, especially if we happen upon another good deal!

My question is, how much money should we keep in reserve?  We have been keeping about 6 months worth of personal expenses as a reserve, should we be looking at 3-6 months of expenses for each of our rentals too?  3 to 6 months of PITI only?  Enough for a few months and a fund for big ticket maintenance items like a roof?  My husband's job is very secure and we have a decent retirement fund but we'd rather not borrow from that.

Thanks in advance for your advice.

Kellu

Bill Gulley · Answer

Brian is right, you will need 6 months piti, for any new loan, you may not need 6 months on all loans at least not in ready cash, 3 months would be prudent. Your savings also counts, if a qualified tax account, they will deduct the penalty and tax rate for withdrawls.

Another reserve in addition is the deductable on your insurance. Consider locations of properties, if properties are 2 blocks away a tornado can damage both, if they are 20 miles apart you can make adjustments.

If an HVAC system blows probably one of the most expensive items that may be uninsured, consider the age and condition of properties and be prepaired to cover it. Your ability to borrow like credit cards can get you past an issue but eventually you need to be able to write a check for such issues.

Besides loan requirements, saying X dollars per property can't be pegged, it depends on the area, material and labor costs, your market, age and condition of the properties and you ability to borrow on short notice, like from savings without penalties or other sources.

Joe O · Answer

I use 6 mo PITI + 6 Months HOA + 6 mo of 20% gross rent per property (for repairs, maintenance, etc.).

It's a decent chunk of cash, but it's actually not as bad as it sounds for three reasons:
1) Banks just care about the 6 mo. PITI, they don't care about the extra HOA and maintenance reserve I outlined above, so I don't have to verify all that as seasoned funds.

2) Like @Mehran Kamari I use retirement funds (IRAs, 457bs, etc.) to show reserves.

The bank doesn't care about "going after" it, they just want to see that you have some funds in case disaster hits and you have to cash it out to pay your mortgage, that you have the ability to do so.  They typically only count the cash out portion (i.e. what you'd have left after paying penalties, taxes, etc.), just like they only count 75% of rents towards income.

3) My properties are pretty cheap. Even with the above formula it's still a little less than 5k/property.

Ned Carey · Answer

I am surprised a bank would even consider that since they can't go after that money

James H. · Answer

6 months gross rents per property would be pretty good. After you get a certain number of properties, though, you may decide to reduce the amount per property. If you had 10 properties that rented for 800/month, I think 20K would be sufficient, rather than 48K in reserves. Banks will want to see 6 months mortgage payments in reserves per property if you are getting loans.

Bill Gulley · Answer

5% of FMV use to be the standard too, many lenders consider that.

Reserves are hard to peg, 6 months is the secondary market requirement on all, not necessairly with all banks. Small banks may not require reserves, we still have rural banks that don't do secondary loans and the poor folks have no clue what some of the guidelines might be.

Reserves are not pegged to piti to just make up payments but an amount deemed prudent for maintenance and occurrances. Now if any lender thought you'd have 6 months vacancy, they wouldn't likely make the loan.

Ned, bet you got that from Larry's post about garnishments (LOL) anyway, reserves are not looked at as to cover payments so much as all other expenses. They have collateral and are not concerned with tapping into your qualified savings, lender's kinda figure that you have already gone through that before they get to foreclosure and it would only be at the tail end when seeking a deficiency judgment that a lender would start looking for your cash, the fact that the reserves can't be touched by a judgment are irrelevant.  :)

Lynn McGeein · Answer

Kelly, since banks will let us use our 401K as the required 6-months per property in reserves required, we don't use another savings account for those reserves.  We do keep a separate account with minimum 6 months of our own primary living expenses plus $10K extra funds designated for expensive maintenance (roof, HVAC, etc.), and then any extra in that account is designated for use towards future down payments.  That account is in a completely separate bank from our regular checking/savings as I've learned from experience that if it's easy to access or transfer, it's harder to keep it funded.  In our regular savings account, we keep at least enough in savings to cover one full months' mortgages for all properties should the worst happen and not one tenant pays.  If we use any of the designated emergency funds, our first priority is re-funding them immediately.  We had an issue with a property manager where we didn't get any rents on 3 of our properties for over 2 months (she collected rents but didn't pay us), and if we hadn't had emergency funds, it would have been very scary.

Mehran K. · Answer

Ned Carey I never thought about it from that legal perspective. Interesting! My limited impression was that the reserves was they just wanted to make sure I had enough to cover the payments in case I ran into road bumps.

According to their rules, retirement accounts get counted at 60% of the balance towards cash reserves. For my Roth IRA, the actual contributions I made are considered a return basis and are counted 100%(I can pull them out anytime without penalty/taxation.) Only the interest gained is at 60%.

Mehran K. · Answer

I have similar goals also to the OP. I'm closing on my first property soon and will be working towards my second right after that.

My lender(also fannie Mae guidelines) wants 6 months reserves on all properties(even primary residence) including the one being purchased. Thankfully my Roth IRA covers all this for now for probably up to property #3 or #4.

My gross rent on property #1(duplex) will be $1075 and I plan to fund the reserve account until it gets to $5-6k. After that, anything after PITI/repairs will go to the stockpile for Property #2's DP, along with any savings I have left over from my 9 to 5.

I wonder though, what I will would do if I sniff out a great deal and I have just enough for the down payment with the cash reserves from Property #1 included. Will I spend the reserves just to get the deal or not? I probably will! lol!

Russell Monson · Answer

My personal formula is a little bit more conservative than 6 months PITI, but my down payment funding plan is much more aggressive than average so I need to have additional cash on hand to balance the risk.  I keep 5% of the fair market value of each of my rentals in cash.  I currently have 5 rentals (3SFR & 2 Duplex).  Once my reserve balance hits $50k I will stop adding to it.  When I get into doing bigger deals (large multifamily), I won't use a rule of thumb anymore so this little rule will go by the wayside.

Deborah Burian · Answer

It has not been our experience that the bank required any reserve to make a loan.  As long as we had the 20% down, and a good history of making the other payments, they were more than ready to go forward.  I confess to a weakness of spending what should be emergency reserves to buy new properties...  It's been such a fire sale the last few years it's been hard to resist and since we don't buy unless the property cash flows, it's worked out ok.  In the beginning, our salaries had to bail us out more than once.

How much cash to keep in reserve?

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