All mortgages require a monthly payment. Typically, the monthly payment consists of the principal repayment, prorated property tax, prorated homeowner’s insurance payment and interest. Of these, your taxes and insurance payments are held in a trust account with the lender, called the escrow account. When you refinance a mortgage, existing escrow accounts are usually closed and a new one is opened specific to the new loan.
To better understand the advantages and disadvantages of escrow accounts and how they work, read below.
Understanding Escrow Accounts. When you pay your monthly mortgage payment, your taxes and insurance are kept in an escrow account held by your mortgage company. When these bills are due, the bank is responsible for paying them for you in a timely manner. Some lenders require you to open an escrow account in order to grant you the loan; others will let you pay the bills yourself.
The Previous Escrow Account. When you refinance a loan, the original escrow account remains with the old loan. Escrow funds, unfortunately, cannot be transferred to new loans, even if it’s with the same lender. All the property tax and insurance payments you have made to that account, since the last payment was made, will be returned to you, usually within 45 days via wire transfer or check.
Using Old Escrow Funds. Because the funds will be sent to you at a later date, it is usually not possible to use held escrow funds from a previous loan to apply toward your new escrow account on the refinanced loan. This will require you to come up with more funds at closing to fund your new escrow account and, depending on the time of year that you are refinancing, the lender may require a substantial amount in taxes to be pre-paid into escrow.
Benefits of Escrow Accounts. If you choose to utilize an escrow account for your loan, you may receive a lower interest rate. The lender becomes responsible for paying your quarterly property tax, as well as payments to your homeowners insurance, freeing you from having to remember to pay them. Due to property taxes being financially burdensome in some cities, being able to split the amount due into 12 equal payments makes it easier to afford for most people.
Opting Out of an Escrow Account. When deciding about an escrow account on your refinanced loan, keep in mind that without an escrow account, the closing costs will generally be lower because you are not depositing funds for future property tax or insurance payments in advance.
On the other hand, without an escrow account, your lender might charge you a waiver fee or a higher interest rate on the loan as their risk increases because they will be relying on you to make timely payments for property taxes and homeowner’s insurance. If you opt to forgo an escrow account and you fall behind on tax or homeowners insurance payments, you could face significant penalties and late fees. You could lose your homeowners insurance coverage, and the tax assessor can put a lien against your property. At worst, you could face foreclosure. All of this would jeopardize the lender’s investment in the property.
Adapted from an article on homeguides.sfgate.com by Grace Keh.