Rental properties have been a great investment for me, but they can be expensive to buy. Although you can make a lot of money from rental properties, it takes a lot of money to buy rental properties and you must have money in reserves to handle vacancies and maintenance. I have 16 rental properties and it has taken a lot of cash to purchase them. They also have maintenance that comes up or will go vacant at times. I have to keep money in reserves for maintenance and vacancies and the bank will also require me to have money in reserves for rentals as well.
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You have to have money set aside to handle vacant months and repairs. Most repairs are minor items that do not cost a lot of money, but some repairs like replacing a roof can cost $5,000 or more. Many times repairs are done when a house is vacant, which means you will not be receiving rent and you have to pay for repairs.
For more information on my rental properties and investing strategies check out my complete guide to investing in long-term rentals.
How much money will a bank require to have in reserves on rental properties?
The money you need to keep in reserves depends on many factors. Older homes will need more maintenance and some homes will have more vacancies than others. One rule of thumb is what lenders will require investors to have in reserves before they will give them a loan. Most lenders require at least 6 months in reserves for all mortgages in an investor’s name. To figure how much cash you would need add up all your mortgage payments, including your personal residence and multiply them by 6.
A bank will require all the minimal costs required on an investor’s mortgages to be accounted for when calculating reserves. Taxes and insurance will be counted when calculating the reserve requirement as well as the mortgage payment. On my rental properties, my mortgage payments which include taxes and insurance range from $450 to $650 a month. I also have to account for my personal residence mortgage payment which is over $2,000 a month. I have 16 rentals, but two of those properties have no loans against them. In total I need over $50,000 in cash reserves to show my bank that I am in a good enough financial position to purchase more rental properties.
Is 6 months of mortgage payments enough reserves for a rental property?
How much in reserves you need will vary with each investor and the properties they own. A huge factor when considering how much money in reserves you need is how much cash flow your rental properties are producing. If you have minimal or negative cash flow you will need much more in reserves. Having to cover part of a mortgage payment on top of paying for vacancies and maintenance can add up quickly. Most banks will also consider the cash flow an investor has on their rental properties when making loans. If you have little to no cash flow it will be harder to qualify for more loans. I suggest buying rentals for cash flow and not appreciation, but if you do have negative cash flowing properties you should have more in reserves than 6 months of mortgage payments, taxes and insurance.
If you have a lot of cash flow coming in from your rental properties you should be able to build up reserves quickly. If you find you are short on cash, I would save cash flow you have coming in until you have a decent amount of reserves saved up. Many of the problems investors run into are easily solved if they invest for cash flow!
If you have one or two rentals you may need more in reserves
If you have one personal residence with a mortgage payment of $700 a month and a rental property with a $500 a month mortgage, you would only need $7,200 in reserves according to bank requirements. However, that is not much money if you have to make major repairs on your rental property. If you have to replace the roof that could wipe out the entire reserve you have in place. You better hope the home stays rented and no other repairs come up while you build the reserve back up again. I think an investor should have at least $10,000 saved up in reserves for their rental properties no matter what the bank says your reserves should be. This assumes your rental properties are basic houses that are in decent condition. If you have old rental properties that are in need of maintenance, you may need to save even more.
The money you keep for reserves on rental properties should not be used for other things
When you have a reserve for vacancies and maintenance on your rental properties, that money should not be used for personal items or buying more rental properties. You never know when you might need to evict someone or make major repairs. If you don’t have the money to complete an eviction or make repairs, you could have major problems renting the home. If you can’t rent the home, you will not be able to bring in more money to cover the expenses. You may find yourself in a big heap of trouble and forced to sell the property.
Rental properties are expensive to buy; it usually takes at least 20% down and to get a great deal you may have to make repairs as well. You have to save more money than what the down payment and repairs will cost you. You need to make sure you have reserves to carry you through the rough times. For more information on financing long-term rental properties, fix and flips or owner occupant homes, check out my E book: How to Finance Multiple Rental Properties. The book explains how to get loans for multiple rentals, for fix and flips or for an owner occupied home. The book is available at Amazon or in PDF format.
For more information on how to buy the best rentals which will make the most money, check out my book: Build a Rental Property Empire: The no-nonsense book on finding deals, financing the right way, and managing wisely. The book is 374 pages long, comes in paperback or as an eBook and is an Amazon best seller.