When deciding to refinance a mortgage, it is crucial to understand the process of what happens to the escrow.
An escrow account holds a homeowner's funds set aside for home ownership-related expenses. When it comes to refinancing, this account might be affected. Often, escrow can remain in the same account, but lenders sometimes require you to close it and establish a new one.
In this article, learn more about the impact that refinancing can have on one’s escrow.
What is Escrow?
Escrow refers to a service that makes it easier for mortgage loan holders to manage their insurance and taxes.
Alas, most homeowners are first introduced to escrow accounts when making a deposit to show they are earnest about purchasing a property. A third party holds this deposit until the transaction completes and then relinquished to the seller.
After closing, financiers and homeowners continue to use escrow accounts to secure the funds intended to pay homeowners insurance premiums and property taxes. As the mortgage is paid each month, lenders set aside a portion for such expenses to be kept in escrow, ensuring continuous and on-time payments.
When Is Escrow Required?
Some mortgage companies require borrowers to open an escrow account as a loan condition. In contrast, others allow homeowners to pay all the bills if they have a solid financial standing.
With conventional loans, borrowers who make a down payment of less than 20 percent are mandated to escrow. As for government-backed home loans, it varies. Home loans with the U.S. Department of Veteran Affairs (VA) require a down payment of 10 percent and proven credit to opt out of escrowing. On the other hand, Federal Housing Administration (FHA) loans require escrow accounts for all borrowers.
What is Refinancing?
Refinancing a home loan is an excellent approach to lower payments, pay off a mortgage, save money on interest, or withdraw home equity. With a refinance, homeowners, in essence, replace their existing mortgage with a new one that, ideally, has better terms.
This process is similar to a home purchase. When applying, the lender assesses the borrower's financial risk to determine the terms and conditions of the new loan. Refinancing can also be accomplished through a different lender.
While a refinance can be an excellent money-saving strategy, consider that closing costs are once again due when making such a decision.
Why Would I Refinance?
When used in a proper manner, refinancing can be a valuable tool to position householders into better deals moving forward. Following are five examples of how a refinance can be a wise financial decision:
- Capitalizing on lower interest rates if the market drops or your credit improves.
- Converting from an adjustable-rate (ARM) to a fixed-rate mortgage.
- Shortening the loan from a 30-year to a 15-year term.
- Cashing out on built-up equity to fund other projects.
- Consolidating and bringing debt under control
What Happens to My Escrow When I Refinance?
In choosing to refinance, homeowners can do so with their existing lender or another creditor. This decision has a significant influence on what happens to their escrow.
Refinancing with the same lender often means the escrow stays unchanged and continues to be used with the new loan. Those who keep their original escrow account should not expect a refund. That is, unless there are significant changes to the property's insurance and taxes.
In contrast, refinancing with a new mortgage company implies creating a new escrow account. If that is the case, the original escrow account must be closed. Homeowners should then receive a refund for their account's remaining balance.
What Happens to My Mortgage When I Refinance?
The creditor uses the new loan to pay off the existing one -- leaving borrowers with one loan and one mortgage payment.
What Happens to the Interest Rate When I Refinance?
Perhaps the most common reason for homeowners refinancing is to secure a lower interest rate. While the amount owed does not change, refinancing can reduce payments and develop into savings. As the real estate market fluctuates, many experts recommend keeping an eye on interest rates to gauge whether refinancing makes sense.
What Is an Escrow Refund?
If you have a remaining balance in escrow after paying off your mortgage or refinancing to a new lender, you should receive an escrow refund. This check reflects the amount of money remaining. Albeit, those with less than a $50 balance may not be eligible.
Homeowners eligible for a refund should receive a check from their former loan servicer after the annual analysis of escrow accounts. During these reviews, lenders ensure the payments match the bills. The timing of these reviews varies. Some lenders may require requesting a refund.
How Do I Refinance My Home?
After going through the initial home buying experience, refinancing seems more straightforward. The average timeline for a refinance falls between 30 and 45 days.
To get a better idea of the process, follow each of these steps:
- Apply to Refinance: Get pre-approved with a lender of your choice. Complete the application and provide them with the necessary documentation.
- Lock In the Interest Rate: Secure the interest rate, so the loan is not at risk of increasing before closing.
- Undergo Underwriting: The lender will review your application, ask follow-up questions, and prepare the loan for closing.
- Get a Home Appraisal: Work with the lender to appraise the property to determine the fair market value.
- Close On the New Loan: Closing day involves the borrower signing multiple disclosures and documents and finalizing the new mortgage.
How Much Will Refinancing Cost Me?
A mortgage refinance often promises long-term savings and benefits, but that also comes at a price upfront. Like taking out a home loan, refinancing requires closing costs.
Refinancing closing costs can vary based on several facets, such as location and loan size. In general, borrowers should expect to pay between two and six percent of their principal. In 2021, reports showed that the average closing costs for a refinance were just under $2,400 before taxes.
What Are the Risks of Refinancing?
Before moving forward with a refinance, consider these five potential pitfalls:
- Refinancing for the wrong reasons: The key to refinancing is timing. Being fixated on interest rate trajectories or large equity cashouts may lead to an oversight.
- Refinancing too often: Homeowners may refinance more than once. Alas, doing so may nullify potential savings due to closing costs and fees.
- Cashing out too much home equity: Withdrawing excessive equity can leave property owners vulnerable to high payments with little buffer should values decrease.
- Paying longer than expected: Refinancing into a mortgage of the same term as the existing loan (i.e., 30-year mortgage into another 30-year mortgage) means starting over. That could also mean accumulating more interest.
- Unexpected closing costs: The potential savings or cash-out opportunities from a refinance may make financial sense, but closing costs are due upfront again, which can be between three and six percent of the loan balance.
How Can I Get the Best Deal on Refinancing?
An escrow account is a vital part of homeownership that should be accounted for when refinancing. The thought of receiving a refund is enticing. Nonetheless, maintaining the existing escrow may make for an easier transition. Whether you choose to refinance with your current lender or choose a new one, consider what will happen to the escrow. After all, refinancing is to get the best deal possible.
To learn more, contact Wesley Mortgage today!
