Tom Kelly: Reserves need to be better explained at closing

I enjoy escrow “reserves” or “impounds” about as much as I enjoy having my car impounded. However, the former can be classified as a safeguard to prevent a mistake, and the latter, the result of a mistake.

When a home sale closes escrow, lenders require sums of money known as reserves to pay taxes, hazard insurance and personal mortgage insurance. The amount of these impounds depends on when in the calendar year the deal is signed. For example, if a sale were finalized today, more money could be held in reserve for taxes than if the deal were to be closed six weeks down the road.

But what comes as a shock to borrowers is the adjustment of reserves during the term of the loan. The average person is uncomfortable with change, especially when it pertains to a fixed-rate loan guarding the roof over one’s head. One of the primary reasons a borrower signs up for a fixed-rate loan instead of an adjustable-rate loan is the predictable – and thereby comfortable – monthly payments.

The reserves issue is getting an awful lot of attention in the industry, especially in light of Fannie Mae’s updating its policies for qualifying borrowers purchasing a new principal residence and converting their existing principal residence to a second home or investment property. The stringent new rule that requires borrowers have a reserve amount set aside equal to six months of principal, interest, taxes and insurance (PITI) payments on both homes when converting the primary residence to a rental or a second home. Previous guidelines did not include reserves on both homes.

Household budgets are created out of necessity. Few can accommodate an extra $200 out of the blue for housing. A lot of work and anxiety may go into accurately estimating monthly payments, only to be tossed into confusion one year into the loan.

It’s true – monthly principal and interest charges do not change over the life of a fixed-rate loan. But insurance and tax reserves can change, especially if your home was undervalued at the time you bought it.

Another way reserves can be affected occurs when another lender obtains the servicing on your mortgage. For example, the lender who wrote your loan generally will not keep it. Most home loans are packaged and sold in the secondary market to investors. The bank that wrote your mortgage no longer owns the loan, but merely retains the paperwork involved, commonly known as servicing.

When the loan is sold in the secondary mortgage market, the rules on reserves rarely change. However, when the actual servicing is sold, demands for additional reserves may result, depending on the lender’s policies.

In a capsule, if your taxes and insurance go up, the lender will ask that you pay in advance to cover the costs. The lender does not want to advance money on your behalf. The bottom line is how much and how often these demands can be made. A lender has the right to establish a cushion to account for fluctuations, but I don’t see how you could make a case for doing it more than one time.

If you handle the taxes and insurance payments yourself – do not have them included in the monthly check to the lender – you will not be susceptible to new reserve requirements. Obviously, though, if your taxes go up, you will be responsible to pay for the increase.

What bothers me is that there is no real notice given at closing that additional tax and insurance reserves could be demanded at any time. Also, the mortgage analysis given to the borrower to explain why the change took place is difficult to read. The reserve analysis is complex, and the calculation itself is complex.

Every now and then, the money pulled out by the lender to pay taxes never makes it to the proper authority. For example, some county taxpayers have received notices that their taxes have not been paid. Even though the lender bills the consumer each month for taxes, the lender has not paid the county.
I don’t believe there are lenders who deliberately do not make the payment, but there are those who are more conscientious than others.

Most of the problems occur when loans are being transferred from one lender to another and some counties allow a grace period for repayment when that happens. But the taxpayer is ultimately responsible for paying the taxes. I think that needs to be spelled out when a home-loan closes – along with the potential for added reserves.

Tom Kelly’s new E-book “Bargains Beyond the Border: Get Past the Blood and Drugs: Mexico’s Lower Cost of Living Can Avert a Tearful Retirement” is available online at Apple’s iBookstore, Amazon.com, Sony’s Reader Store, Barnes & Noble, Kobo, Borders Books, Diesel eBook Store, and Google Editions.