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 manipulatewhich is why you should not solely rely on them when making your choice.