Why do I need reserves and which assets count?
When buying a home, a major part of your financial profile is determined by your assets – and more specifically which of these assets can be considered “liquid.” Both lenders and coop boards will have different liquid assets requirements, and what they consider liquid may vary...
What Is Asset Liquidity?
Assets are items that you own that have value. Among other things, assets can include cash in your pocket, savings accounts, stocks, jewelry, real estate, even things like professional degrees. These assets can be classified as liquid or non- or il-liquid. When an asset is “liquid,” it has cash value or can be easily converted to cash.
Common Examples of Liquid Assets:
Deposit account funds (checking and savings)
Certificates of Deposit (CDs)
Common Examples of Non-Liquid Assets:
Real estate property
Furniture & other personal effects
Being the beneficiary of revocable or inter-vivos trust
Retirement accounts straddle the line. If you are over a certain age (close to the age where you can access the funds), some may consider retirement funds liquid (usually banks, but maybe not coops). Even if you are not at or close retirement age, banks (but not coops) may take into account your retirement funds in determining whether you meet reserve requirements. For example, many lenders require that you to have at least 6 months’ worth of liquid assets available to pay your principal and mortgage interest, and some lenders may reduce this to 3 months if you have adequate retirement funds. Co-ops typically have far more stringent requirements – some may require that you have as much as 2 years of “post-closing reserves” meaning you would need to have 24+ months of your anticipated monthly mortgage principal, interest, and building maintenance payments in truly liquid assets after you close.
Why Is Asset Liquidity So Important?
Liquidity is important in cases of financial emergency. Imagine that you own a parcel of land that is quite valuable, along with some rare Picasso paintings that your dear, old Aunt Beverly left you in her will. Aside from that, you have a decent job, however your monthly expenses are around the same as what you’re making, so you can’t really save that much. But when you look at your balance sheet, you’re pretty well off, at least “on paper.”
Now say an unfortunate financial emergency befalls you, like an unexpected auto repair or medical bill. You still have to pay your mortgage, but you can’t because you don’t have anything extra saved up, and you don’t want to borrow the money from someone else. Now you could sell that parcel of land or one of your pieces of art, but that takes time. Appraisals must be made, buyers must be courted. These things take time – time you don’t have – and your mortgage is due before you would be able to liquidate these assets. Those assets don’t help you in a financial emergency because, relatively speaking, they’re not liquid enough to do you any good when you need them.
Because of this, lenders and co-ops alike require that prospective buyers itemize their assets carefully. This ensures that in the unlikely event of an emergency, the chance that the buyer will default on their loan, or be unable to pay monthly building fees, remains low.