How Much Reserves are Required When Refinancing?

I had a great question yesterday from a potential client who asked how come my Good Faith Estimate was showing more reserves being required than the other lenders he was comparing me to.

Reserves are what the lender collects upfront to make sure they have enough funds to pay taxes and home owners insurance.  On the Good Faith Estimate, this also includes prepaid interest.

The other lender was showing 6 months of property taxes and 3 months of home owners insurance.  My estimate had 7 months of property taxes and 10 months of home owners insurance.  My Good Faith Estimate reflected higher reserves than the other lender.  My estimate is more accurate…but doesn’t look as attractive as my competitor.  My bottom line appears a couple hundred dollars higher.

The other lender can easily shrug off the difference (and they do) when the consumer is at closing and learns the amount due at closing is different than originally anticipated.   They’ll say that a good faith estimate is just an estimate and that reserves are prorated based on the date of closing…and they’re pretty much correct.

The amount of property tax reserves required is based on when the first mortgage payment is due.   I would say it’s an accepted standard for Loan Originators to use 6 months for property tax reserves…especially when it’s an estimate for a purchase and the closing date is unknown.  With a refinance, I know I’m probably closing in the next 30-45 days (or 60 days if we’re subordinating a second mortgage) and I’ll adjust my estimate accordingly.  I don’t want clients to be surprised at closing or after they’ve made a decision to work with me.

Unless a loan originator knows when the borrower’s home owners insurance is up for renewal, they ought to use a higher amount (like 8-10 months)–we’re all ready guessing (in most cases) how much the home owners insurance is.

With a refinance, unless I’m certain that we’re closing at month end, I use 15 days of prorated interest.  Again, not a pretty figure–15 days of interest is almost half of your mortgage payment.   The prorated interest will be adjusted based on the actual day the mortgage is closed.  Closing towards month end reduces the prepaid interest.  Closing in the middle of month will create about 15 days of prepaid interest.

I would question working with any loan originator who does not provide an accurate good faith estimate when selecting your next mortgage professional.  Good faith estimates (and APR) are easy for LO’s to manipulate which is why you should not solely rely on them when making your choice.

EDITORS NOTE: This post was written prior to HUD’s 2010 GFE which is less easy to manipulate…however, I still see some pretty interesting stunts despite the regulations with the new Good Faith.


  1. Cindi Gardner says

    Hey Rhonda – thought it was interesting how different this issue is state to state. Unless the borrower is setting up impound accounts – there are several differences down here: unless we are in the month prior to property tax installments due date – no property taxes are collected at the close of a refinance. Homeowners insurance premium needs to have 4 months worth of the annual premium left after the close of escrow – but in some cases (cash out) the requirment is 12 months – otherwise the annual premium is collected at the close (or can be paid directly to the insur. agent). As for prepaid interest – I always find it helpful to explain ‘what the heck that means’ to my borrowers. Seems like some think ‘pre paid interest’ is an extra fee, rather then knowing that mortgage interest is ALWAYS collected in arrears – EXCEPT on a refinance – when the number of days remaining in the month the new mortgage closes in are collected up front (prepaid), and from that point on the interest is paid “after the money has been used”…which creates an impression that they are ‘skipping’ a payment. Such a complicatd issue for consumers – especially when it’s not standard in all states, and if they have an impound account, as in your blog examples. Thank you for putting such valuable consumer education out here!!

  2. Cindi, proving once again WHY I stick to providing mortgages in Washington State only… I could never keep track of procedures in 49 other states. Thanks!

  3. Cindi,
    In a refi situation such as this one described, how are the impounds from the current mortgage being refinanced refunded back to the borrower?

  4. Rap2321, I’ll see if I can track down Cindi to respond to your comment.

    With what I’ve described in the main post, what happens most often is the lender that is being paid off will refund the balance of the reserve account to the borrower in a few weeks after closing.

  5. Cindi Gardner says

    Yes – in all states, if a mortgage loan is paid off (for any reason, including the sale of the property) and there was an impound account in place – the lender will refund the balance typically within 3 to 4 weeks. I’ve done mortgages in California and Georgia over the past 24 years, and have had clients in both areas transfered in from multiple states – have never seen a variation on this. So regardless of whether the new loan is going to have an impound account or not – if the old loan had one – 3 to 4 weeks AFTER old loan closed – money is refunded. ** Also – that old impound account can not be used to fund the new impound account – so Rhonda’s original post about gathering reserves has to happen to set up a new impound.

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