Refinancing your mortgage means getting a brand new mortgage loan on your home. You can refinance into a loan with a different term and interest rate. It’s usually in your best interest to take a shorter term, or one similar to the number of years you have left on the loan. Otherwise, you add more interest to the loan than is necessary. Something that needs serious consideration as well, though, is the escrow account.
Specifically, you want to determine if you want to net escrow or start fresh.
What is an Escrow Account?
First, let’s look at the escrow account. It’s a separate account that your lender sets up to pay your real estate taxes and homeowner’s insurance. Rather than you being responsible for the payments, the lender handles it for you. In exchange, they require 1/12th of your annual payments due each month. The lender separates the principal, interest, and escrow payments accordingly. The escrow payments go directly to your account. The county and homeowner’s insurance company then bill the mortgage company for payment.
What Happens to Your Escrow When you Refinance?
Depending on the time of year that you refinance, you may have a rather substantial escrow account with your old lender. They usually hold at least a 2-month cushion, plus any money that has accumulated before the bill is due. Let’s say you refinance right before your real estate taxes are due. This means you could have between 6 – 8 months’ worth of real estate taxes sitting with your lender. Once you refinance and pay off that loan, though, the lender will not pay your taxes any longer. Instead, they will refund the escrow account money to you. It usually takes around 45 days to receive the refund.
What is Net Escrow?
One option you have is to request a net escrow. Not all lenders and loan programs allow this, but it’s worth asking.
When you net your escrow, your old lender pays the new lender your escrow money rather than refunding you the money. The new lender uses this amount as a credit towards your new escrow account. Here’s an example:
You apply for a new refinance. Your new lender needs $3,000 to set up your new escrow based on your real estate tax and homeowner’s insurance due dates. Your existing escrow at your current lender has a balance of $2,000. You can either cough up the $3,000 and wait to receive your $2,000 check from your current lender or ask the lender to net escrow.
If your lender agrees, your old lender will send the $2,000 to the new lender rather than to you. You now have a $2,000 credit towards your escrow. This leaves you owing $1,000 rather than $3,000 at the closing. This can help you qualify for the loan and be able to afford the closing costs plus the escrow funds.
Do You Have to Set up an Escrow?
Now, you might wonder what would happen if you don’t set up an escrow account. It varies by lender. Some lenders and loan program, such as the FHA loan, require an escrow account, there’s no way around it. If, however, you have a conventional loan and you owe less than 80% of the home’s value, you may waive your right to escrow. However, it may cost you. Some lenders charge 0.25% of the loan amount at the closing to waive the escrow.
Lenders charge this fee because waiving escrow is a risky move for them. If you don’t pay your taxes, the county can take first lien on your home. If you don’t pay your homeowner’s insurance and your house burns down, there are no funds to pay the mortgage company back or to build the home back up.
So generally, yes you have to create an escrow account. Whether you net escrow or not is up to you. In many cases, it just makes sense as it takes less cash out of your pocket. But, it’s up to your personal preference as well as the lender’s offerings.