The VA loan provides eligible borrowers the ability to buy a home with no down payment – an incredible benefit. But, no down payment does not equal no closing costs. Most borrowers need some funds to close a loan. This leads many people to ask about the VA loan: are cash reserves/liquid assets required? It depends on your situation, and we’ll use this article to answer this question in detail.
- VA Loan Overview
- What are Cash Reserves/Liquid Assets?
- VA Loan Situation #1: Cash Reserves for Single-Family Home Purchases
- VA Loan Situation #2: Cash Reserves for Troops Nearing Active Duty Separation
- VA Loan Situation #3: Cash Reserves for Borrowers with Other Rental Properties
- VA Loan Situation #4: Cash Reserves for Borrowers Buying a Multifamily Property
- Final Thoughts
VA Loan Overview
The VA loan has its roots in the Servicemen’s Readjustment Act of 1944 – the original “GI Bill.” While the loan program has changed over the years, it currently offers eligible veterans and active troops the following terms:
- No down payment required
- No private mortgage insurance (PMI) required
- Low interest rates
- Streamlined refinancing option via the Interest Rate Reduction Refinance Loan (IRRRL)
Of note, the Department of Veterans Affairs insures the VA loan. It doesn’t actually lend and service loans – individual lenders do. Despite this system, the VA does, in fact, impose certain requirements that borrowers must meet. In particular, certain borrowers must demonstrate cash reserves/liquid assets, which we’ll discuss in the remainder of the article.
What are Cash Reserves/Liquid Assets?
Prior to outlining cash reserve/liquid asset requirements, we need to define these items.
When lenders issue loans, they assume a certain amount of risk that the borrower will stop repaying that loan. To partially offset this risk, lenders make sure that borrowers have enough regular income to cover monthly mortgage payments.
But, lenders also want some protection in case a borrower loses his or her regular income source (e.g. gets laid off from a job). Cash reserves/liquid assets provide this additional protection. In theory, if borrowers lose a job, they can tap these reserve funds to continue paying their mortgages. For instance, a lender may require that borrowers have six months of mortgage payments in reserve.
Cash reserves, as the name suggests, are reserve funds saved in a cash account (checking, savings, or money market). However, lenders also normally accept liquid assets to meet reserve requirements. Simply put, a liquid asset is one that can be quickly turned into cash. Common examples include:
- Certificates of deposit (CDs)
- Stocks
- Bonds
- Mutual funds
- ETFs
- Funds held in certain retirement accounts
The VA’s guarantee of VA loans somewhat reduces risk for lenders. If a borrower defaults (i.e. stops repaying), the VA will pay the lender a portion of the outstanding loan balance. For this reason, many borrowers will not require cash reserves/liquid assets to qualify for a VA loan. But, as we’ll outline below, some borrowers in unique situations will need reserves for their VA loans.
VA Loan Situation #1: Cash Reserves for Single-Family Home Purchases
Generally speaking, borrowers using the VA loan to purchase a single-family home do not require a traditional cash reserve. That is, lenders won’t require three to six months of cash reserves/liquid assets to approve the loan.
However, borrowers will need to demonstrate that they have enough cash on hand to cover the VA loan’s closing costs. While the VA loan doesn’t have a down payment requirement, borrowers do need to pay closing costs. Some of these items – like the VA loan funding fee – can be rolled into the loan principal and paid off over time. Others need to be paid in cash when you close on your loan.
Every loan situation is unique. But, as a rule of thumb, borrowers should plan for paying 3% of the loan amount in closing costs. For example, you should set aside $7,500 on a $250,000 loan ($250,000 x 3%). Your actual closing costs may be more or less, but this rule of thumb provides a solid guideline for planning purposes.
To verify that you have enough cash or liquid assets on hand to close, lenders will review bank statements, savings accounts, and any investment accounts you plan on using to cover closing costs.
VA Loan Situation #2: Cash Reserves for Troops Nearing Active Duty Separation
To verify military income, lenders review your Leave and Earnings Statement (LES). This LES also includes your projected date of separation from the military. If your LES shows a separation date within 12 months, you may need to demonstrate cash reserves/liquid assets to qualify for a VA loan.
Borrowers with a separation date within 12 months can avoid a reserve requirement if they meet one of these criteria:
- Documentation confirming your re-enlistment
- An accepted civilian job offer
- A signed letter from your CO stating re-enlistment eligibility plus a signed letter stating that you intend to re-enlist
If you don’t meet one of the above scenarios, the VA requires that lenders get “documentation of other unusually strong positive underwriting factors,” to include a 10% down payment and “significant” cash reserves.
The VA does not define exactly what this “significant” cash reserve should be. But, between the 10% down payment requirement and these additional reserves, borrowers in this situation largely lose the benefit of the VA loan, that is, a no-down mortgage.
VA Loan Situation #3: Cash Reserves for Borrowers with Other Rental Properties
Borrowers who own other rental properties will also need to demonstrate cash reserves/liquid assets to qualify for a VA loan. Essentially, the VA wants to confirm that, if you lose a tenant at one of these other properties, you can still cover the mortgage payments plus your VA loan payment.
The VA requires reserves totaling three months of principal, interest, tax, and insurance (PITI) payments for the rental property(ies). For example, say the mortgage on your rental property is $1,500/month, which includes all the PITI elements (as most residential mortgages do). You would then need to demonstrate at least $4,500 in cash reserves/liquid assets ($1,500/month x 3 months).
Furthermore, if you’d like the lender to consider your rental property income towards loan qualification, you’ll need to submit two years of signed tax returns reflecting that income. Many lenders also won’t accept 100% of rents. Rather, many accept 70% or 75% of rental income towards VA loan income requirements.
VA Loan Situation #4: Cash Reserves for Borrowers Buying a Multifamily Property
The last reserve scenario involves buyers using the VA loan to purchase a multifamily property (duplex, triplex, or quadplex). To qualify, these borrowers will need to document at least six months of cash reserves/liquid assets for the future VA loan’s monthly payments (PITI).
For example, say you plan on buying a quadplex, living in one unit, and renting out the other three (which the VA allows). And, assume that the total monthly mortgage payments (PITI) on this future VA loan total $3,000. In this situation, you’d need cash reserves/liquid assets of at least $18,000 ($3,000/month x 6 months).
Additionally, to include the rental income from the other units, you’ll need to demonstrate a proven track record of prior property management experience. And, lenders still won’t accept 100% of the future rents towards your income requirements. Rather, VA guidelines accept 75% of documented rents, that is, as demonstrated by a professional appraiser’s report or current lease agreements.
Final Thoughts
As outlined above, most borrowers will not need cash reserves/liquid assets to qualify for a VA loan. They will need to show that they have enough funds to cover closing costs, though. On the other hand, borrowers in unique situations involving military separation and/or rental properties will require cash reserves/liquid assets to qualify for a VA loan.
Maurice “Chipp” Naylon spent nine years as an infantry officer in the Marine Corps. He is currently a licensed CPA specializing in real estate development and accounting.
