Escrow Accounts – How They Work

by Dave Wirsching on January 22, 2009

If you are fortunate enough to be able to refinance your mortgage loan into a lower interest rate, you should know how your escrow account with the new and current lender will be handled.  The mechanics of escrow accounts are complicated, and many borrowers want to know: What is escrow, and where does the money go?

Why Do Lenders Hold an Escrow?

Lenders want to make sure that its collateral (your property) is insured and that the taxes are paid on time.  Many lenders require that borrowers establish an escrow account to make sure that these bills are paid.  Lenders may require escrow only for taxes or insurance or for both taxes and insurance. The escrow account is established at the time of settlement, and the funds for establishing the account are shown on the HUD-1 Settlement Statement.   The funds shown on the settlement statement represent the starting balance for the account, and regular contributions to the account are made as part of your payment schedule.  Throughout the year, payments to your insurance carrier, school district and other local taxing authorities are made from the account.

In addition, most lenders require any tax and/or insurance bills due within 60 days of settlement be paid on the HUD1 Settlement Statement.  In most Pennsylvania suburbs, the local and county tax bills are mailed as early as the first week of February with the school tax bills mailed in July.  If you own property in the City of Philadelphia, you will receive one bill only and it is issued in December for the upcoming year.

What Happens to the Current Escrow Account When You Refinance?

As for your existing escrow account, once the mortgage payoff funds are posted, any monies currently being held in escrow with your current lender will be returned to you within 2-4 weeks directly from that lender. The existing escrow account cannot be transferred to the new mortgage lender UNLESS:

  • Your current lender is the same as your new lender.  Your payoff will be reduced by your current escrow balance.
  • Your current lender is NOT the same as your new lender. But, luckily for you, your current lender does not want to be bothered with sending a check later so it reduces your mortgage payoff by the amount it currently holds in escrow.  Very few lenders will offer this option unless you refinance directly with them.

How much Money Should I Expect to Place In Escrow at Settlement?

In either scenario above, you can expect to place an additional 1-2 months of taxes and insurance into the new escrow account over and above your current escrow balance.  Your situation may look like this: You owe $100,000, your current escrow balance is $1,500, and your current monthly escrow payment is $200.  At settlement, your payoff will be $98,500.  Your new lender will require you to place $1,800 into the new escrow account.  Remember that only $300 of that is new money, the other $1,500 represents the balance in your existing escrow account.

What if you are not refinancing with your current lender and the current lender does not offer an escrow credit on the payoff statement?  In this case, you will have to fund the new escrow account at the time of settlement and then wait to receive a check back from your existing lender.  Keep in mind that it is possible that the monies placed in escrow at settlement will be more than your escrow refund. Two reasons for this are that you are skipping a payment (more about this in my next post) and quite possibly, your current escrow account is not fully funded due to increases in taxes and/or insurance billings, creating an escrow deficit.

Keep in mind that all lenders don’t behave the same but most do, so, you may have a lender that does not fall into the above descriptions.

{ 3 comments… read them below or add one }

1 Kirstin March 30, 2012 at 12:15 pm

Can they make you sign a document during refinancing to send the (original lender’s) escrow reimbursement check to themselves?
So I wouldn’t get the check in the mail, they would…

2 Francine D'Elia Wirsching April 2, 2012 at 9:18 pm

Hi Kirstin, A lender can ask you to sign anything (and I have seen it!) but have not had the experience of an assignment of an escrow from one lender to another and I don’t know of a lender that would honor such a request. I am curious as to how the new lender would track that assignment of escrow on the HUD1 – what if the original lender refused the request? Would you then have to send the money to the new lender post closing? In my 26 plus years, I cannot recall once instance where there was an assignment of the escrow.

3 V.F. January 17, 2013 at 1:42 pm

Actually, that is something this is common. It is called “netting escrow”. So if you are short to close, your new lender can have your current lender give them the money in your escrow account to cover the shortage. That way, you, the borrower would not have to pay thousands of dollars out of pocket to refinance. Your current lender is required by law to refund you the money in your escrow account. So why wouldn’t they give it to your new lender to cover your incurred costs? Plenty of lenders agree to it. It does not matter to them because they do not get to keep the money anyway!

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