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Refinancing Your Home Loan? Make Sure to Order a Net Escrow Payoff From Your Current Lender.

September 24, 2015

Mortgage-Refinancing-1

Just in Case You May Not Know: What is An Escrow Account?

An escrow account is an account that was set up with your lender, which holds funds that is used to pay for your property taxes and homeowner’s insurance when they become due. Each month, the lender collects the escrow portion of your payment and deposits it into your assigned escrow account. Most lenders also require that you maintain a cushion in the account, which means that there can be a surplus when you pay off the loan, even if the lender already paid for your taxes for the year.

When you refinance your loan or pay off your mortgage, the lender must close your escrow account. If you request that the balance of your escrow account apply to your mortgage payoff, some lenders will honor your wishes. However, banks typically prefer to return the balance of the account to the borrowers instead.  If the lenders offers to issue a net escrow payoff you should take advantage of it.  It really doesn’t make sense not to; netting your escrow makes the process quicker and easier for both parties involved. When you refinance, you have two options with your old escrow account: you can pay the new escrow amount out of pocket and receive a check for the old escrow account after the payoff, or you can net (or apply) the escrow and use your old account funds to cover the difference for your new escrow. The new escrow in your refinanced mortgage is going to be a part of mortgage costs either way, so if you don’t have the cash at hand to cover it at that moment, netting your escrow is extremely helpful.

Keep in mind when refinancing it always best to seek the shortest term mortgage.  For example, maybe you are currently in your seventh year of your thirty year mortgage.  If you are refinancing into a 30 year mortgage you are starting all over again and paying more interest versus staying in your current loan.  Consider refinancing into a 15, 20 or 25 year term to lower the total interest paid in the new loan to maximize the most savings.  If you should choose to refinance consider only refinancing if you are lowering the payment about 1%, need to refinance out of a balloon payment mortgage, converting from FHA to Conventional, removing private mortgage insurance or taking cash out for financial endeavors (debt consolidation, medical emergencies, home improvements, auto purchases, college tuition, etc).  Remember the ultimate goal is to have your mortgage paid free and clear into retirement.

What Does Net Escrow Mean?

If you are considering refinancing your home loan, you may be able to take the credit in your existing escrow/impound account and apply it as a credit toward the new loan.  Most home loans have impounds accounts set up for the lender to set aside at the start of a mortgage by a third party to cover pop up expenses like property taxes, or insurance premiums. It’s a helpful way to have these expenses covered ahead of time by cash you put aside, so you don’t have to juggle them with your mortgage payment and other bills.  It is most useful when doing a FHA Streamline Refinance to lower the funds needed at closing.  Another reason it helps is the next half of property taxes may be due and the new lender requires the funds be collected upfront if due within the next 90 days.  Homeowner’s insurance policies may be due for their annual premium too.  Netting escrow may not apply to all loan types. The Federal Housing Administration (FHA) allows FHA loans to net escrow when refinancing, but not all mortgage companies do so make sure you check with your mortgage provider to see if you qualify for this. When it comes down to it, you’re going to have to pay for escrow when you refinance, and it’s a better deal to net it.  Mortgage payments are always made in arrears.  If you close by the end of the month you will be able to defer the next month’s payment and your first payment will be due the following month on the 1st.  This may help to offset some of the cash to close.

Why Wouldn’t Someone Request for a Net Escrow?

A point of confusion for some clients comes when comparing their existing home loan and the new one, which may have different terms. For example, your refinanced escrow amount could very well be more than the one on your existing loan; if your old escrow account was for $2,000 and the refinanced escrow was $3,500, you’d need to bring $1,500 to closing if you don’t want that added to your refinanced loan. Also, if you decide to net your escrow, the discount will not occur until the payoff is ordered, so it’s usually the last thing to happen when refinancing. This can startle some people because when it’s last to occur, a reimbursement check seems much more appealing in a short-term sense. This chart uses the hypothetical example of having a principal balance of $100,000, a refinanced escrow of $3,500, and an “old” escrow of $2,000.

Other Helpful Information

The Real Estate Settlement Procedures Act requires lenders to abide by certain guidelines when they maintain escrow accounts for borrowers. Under RESPA, lenders cannot maintain a cushion that exceeds two times a monthly escrow payment. When the escrow account’s balance is more than $50 over its limit under RESPA, the lender must return the excess amount to the borrower within 30 days of its discovery.

RESPA’s statutes don’t expressly prohibit lenders from applying escrow balances to mortgage payoffs. However, because applying the balance to the payoff can cause problems, some banks prefer to return it to the borrower instead. For example, if a borrower incorrectly estimates the escrow account’s balance and reduces the amount he pays toward the mortgage balance, the payoff may be incomplete and interest will continue to accrue.

After you pay off your loan, the lender must close your escrow account, regardless of whether the balance is applied to the payoff. If you still own the home that secured the loan but you no longer have a mortgage, remember that you must make your own home insurance and property tax payments during the year. If you refinanced your home, your lender will open a new escrow account and begin making the payments for you.

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