One of the important things to consider when refinancing is how you want to fund the closing costs and new escrow account. There are several ways to handle these items and a couple of big ideas that can make a difference in the decisions you make.
First, let’s explore what goes into each of these categories.
Closing Costs: One component is called “Closing Costs” and that category covers the actual expenses in connection with getting the loan. This includes items such as:
- Underwriting or Bank fee
- Appraisal (an independent valuation of the property you are buying)
- Credit report
- Flood Certification (a report that identifies whether the property is located in a flood zone)
- Tax Service fee (a report that verifies the real estate taxes)
- Closing or Settlement charge (the attorney’s fee for representing you and the bank)
- Title Search (a detailed examination of the ownership history and related events)
- Title Insurance (required by all lenders to protect against any claims against title)
- Recording fees (charges for recording the title and mortgage documents in the land records)
- Miscellaneous (fees for a variety of transaction-related services such as wire and courier fees)
Escrow Account: The other component involves establishing an escrow account for the payment of taxes and insurance with the new lender. Here’s a summary of what to expect:
- You’ll need to fund the escrow account with enough money so that the next-due tax bill can be paid. The amount needed will depend on how often your taxes are paid (most towns collect twice a year) and when the next due date is.
- You will need to fund the escrow account with enough money so that the next-due insurance bill can be paid. The amount needed will be determined by subtracting the number of payments you will make before your next renewal date from 14 months (that’s the highest balance needed in your account).
- It’s worth pointing out that the lender is required to keep a buffer equal to 2-months of taxes and insurance to ensure that as costs rise – and they will – they can use the funds in the buffer to pay the applicable charges.
- Last, you’ll pay the per day interest costs on your new loan from the date of closing up to and including the 1st of the next month. A couple of important comments about this:
- It is customary to use a default of 15-days of pre-paid interest when estimating your costs on the Loan Estimate. Please know that you’ll only pay for the actual number of days involved.
- Mortgage interest is charged in arrears. That means that your mortgage payment due, for example, on July 1st is for the use of the money in the month of June.
- Within 30-days after closing, your current lender will send you a refund of the balance of your escrow account. That’s your money to keep and is also the cornerstone of one of the Big Ideas in this article:If you have sufficient savings to fund the new escrow account setup, it is a smarter financial decision to do that. That’s because you’ll get almost all of the money you “invest” in your new escrow account back from your current lender within 30-days.
If you have sufficient savings to fund the closing costs, that’s an even smarter financial decision. Not only because you aren’t increasing how much you owe but also because, over the course of your mortgage, you’ll end up paying back 3 -4 times as much as you borrowed in extra interest. Moreover, financing the closing costs and new escrow account increases the amount your home needs to appraise for; if you are close to the maximum allowable or the additional amount means that you have to pay PMI, it can make the difference between getting the loan or not.