What Happens to Escrow When You Refinance?
Understand how your existing escrow account is handled and a new one is established when you refinance your mortgage.
When refinancing a mortgage, understanding the role of your escrow account is important. An escrow account is a fund established by your mortgage lender. It collects a portion of your monthly mortgage payment to cover anticipated property taxes and homeowner’s insurance premiums. This arrangement ensures these recurring property-related expenses are paid on time, protecting both the homeowner and the lender.
Understanding Escrow in Refinancing
Lenders require escrow accounts to safeguard their investment in your property. By collecting funds for property taxes and homeowner’s insurance, the lender ensures these obligations are met, preventing issues like tax liens or lapses in insurance coverage. This setup provides convenience by consolidating large, periodic expenses into smaller, monthly contributions.
Escrow funds typically cover property taxes, homeowner’s insurance, and sometimes private mortgage insurance (PMI) or flood insurance. Each month, a portion of your mortgage payment is allocated to this account. When the bills become due, your mortgage servicer disburses the funds. This helps homeowners avoid the burden of saving for and paying large, infrequent bills in lump sums.
The Fate of Your Old Escrow Account
Upon the closing of your refinance loan, your previous mortgage is paid off, and your old escrow account closes. The former lender reconciles this account to determine if a surplus or a shortage exists. This reconciliation involves comparing the total funds collected with the total disbursements made for taxes and insurance.
If there are excess funds in the old escrow account, this is a surplus. The former lender is required to refund this surplus to you, typically within 20 to 30 business days after the old loan is paid off. This refund usually arrives via check or direct deposit. These funds cannot be transferred directly to your new escrow account, even if you refinance with the same lender; you will need to fund your new escrow account separately at closing.
Conversely, if the old escrow account has a deficit, meaning not enough funds were collected to cover expenses, this results in a shortage. Shortages can occur if property taxes or insurance premiums increased unexpectedly. The former lender may require you to repay the outstanding amount. This repayment might be requested as a lump sum or spread out over a period.
Establishing Your New Escrow Account
As part of your refinance closing, the new lender will establish a new escrow account to manage your ongoing property-related expenses. This new account requires an initial deposit at closing. The amount is calculated to ensure sufficient funds to cover upcoming property tax and homeowner’s insurance payments, along with a mandated cushion.
The initial deposit typically covers a few months of anticipated property taxes and insurance premiums. Lenders are permitted to collect a cushion amount, usually up to two months’ worth of escrow payments, to account for potential increases in these costs. Limits are set on the amount lenders can require for this cushion. Once established, your new monthly mortgage payments will include the calculated escrow amount, which the new lender will use to pay your property taxes and insurance premiums as they become due.