Yes, there certainly is. If everything works as well as it should, the escrow service will save you the personal headache of keeping up with the property tax and insurance payments schedule all through the years of your mortgage. Even the loss of a certain amount to the interest that the lender is going to keep, will feel like a fair fee for good service. If the service is good… To determine whether it is, read about escrow trials and tribulations in my special article.

The system of mortgage escrow accounts was created with good intentions. On the one hand it was to make the lender happy, because the lender got some guarantee that no lien prior to his own will be put on the mortgaged property through taxes or insurance, on the other hand, it was to save the borrower the pain of large lump sum insurance and tax payments. Everybody was expected to be happy, and that’s how it has worked for many people since, but sometimes even the best-laid plans fail.

Ideally, the system works as follows: when you sign your mortgage contract, among other things you agree to trust the property taxes and insurance to be paid by the lender with the money from your special set up for this particular purpose escrow account. Thus, in the course of your mortgage’s life, every period mortgage payment will need to contain a certain extra amount that is deposited into your escrow account. When the time comes, the lender takes the initiative and pays the taxes and insurance premiums in a lump sum using the money accumulated in the account. In other words, you, as a borrower, don’t have to pay the bulk money yourself, you save it gradually, thus making the big payment less painful. Just fine, you’d say, but why do I need the lender to do it for me, if I feel quite capable myself? It’s a fair question. One side of the story is your advantage, which is in the simple fact, that you don’t have to beat your brains out trying to remember when and how much of these actually very important payments you have to make. No other advantages for you, though. They are all on the other side – on the lender’s side. First of all, this way the lender makes sure that the property stays intact (or at least insured against damage) and free from any other lien but his. If the property taxes and insurance remain the borrower’s responsibility, there is always a chance that for some reason the borrower may fail to fulfill these obligations. If that happens, the tax authority, for example, may place a lien on the property that is higher than the lender’s lien. No lender would be happy with such a turn. Another a little bit less straightforward advantage is the interest on the escrow account money that the lender gets to keep to himself. It is usually not a huge amount, however it makes many people wonder if it’s a little bit too much of a present to the lender. Especially when they realize what kind of service they are paying for.

Now, about the original good intentions … The whole system has fallen victim to human greed. Not totally! There are a lot of responsible lenders who do take care of the escrow business properly. The sole purpose of my dramatic overstatement above is to draw your attention to a potentially very grievous situation you may find yourself in, if you don’t look into it in advance.

The problem is that escrow accounts are among the most abused, intentionally or accidentally, mortgage matters. The biggest abuse is a complete failure of the servicing agent to make any of the tax and insurance payments due. Sometimes because of unintentional carelessness, sometimes it’s a deliberate abuse, when the money is withdrawn from the account, but not paid. Just gone. The unaware borrowers may find out a couple of years later that their tax debt is about to cost them their home. When you sign a contract, you trust the other party to perform as agreed, especially in a matter as serious as a mortgage. A lot of borrowers trust their lenders too much and do not keep an eye on the escrow account activity. Even though this is exactly the idea of an escrow account, such carelessness puts their money or even their homes at big risk. So, what was that only borrower’s advantage? – Right. Nerve-racking 24/7 doubt.

Unfortunately, it is very hard to tell in advance if the lender will be honest and efficient servicing the escrow. If the lender services the account himself, you can talk to other customers in advance, read some reviews, but if the lender sells the servicing to some other servicing agent, which happens a lot, it is practically impossible to foresee the quality of service.

• taxes and/or insurance are not paid
• the account is charged twice
• taxes and/or insurance are underpaid
• tax and/or insurance payments are late
• monthly payment to the account increases unexpectedly

These are just a few of the most common problems that occur. Each of them is potentially very dangerous. You can never be totally sure that nothing of the kind is happening to you, but you can try and keep things under control to minimize the possible damage:

• How much is a monthly escrow payment? Before you buy a house, contact the county property appraiser and tax collector to find out how much the fully assessed property taxes will be, as well as an insurance agent for an estimate of how much your homeowner’s insurance premiums will be. Find out about other payments to be placed in escrow. You need the numbers to estimate the extra amount to be added to your monthly mortgage payment as escrow. To calculate that, you sum all the tax and insurance premiums to be paid within the 12 months following the closing date, and divide the result by 12. For example, taxes – $600 paid July 15 and $780 paid December 13 and hazard insurance – $300 paid September 10 add up to $1680. Divide this total amount by 12 (number of payments in a year). $1680 divided by 12 = $140. This is your monthly escrow payment. However, the tax and insurance payments come due quite unevenly throughout a year. It may well so happen that a large payment is due in the very beginning, when the amount accumulated in the escrow account is not enough yet to cover it all. In this case, the lender pays your taxes in full on time and then gradually returns his money as you refill the account with your new monthly payments. The balance for a year looks something like this:

I strongly recommended you try and create a trial year balance like this one for your particular situation. If you live in an area where, for instance, flood insurance is due every 3 years, the trial balance has to include all the three years for an accurate result. Why is a trial balance so important? It gives you information about the month, where the balance is the lowest – in our sample case it is December. As you can see from the table above, the balance is actually negative all the way. Now, we cannot possibly expect the lender to be as generous as to pay everything in advance using his own funds, can we? The lender’s solution to the problem is a financial cushion that he requires you provide for him. Section 10 of the Real Estate Settlement Procedures Act (RESPA) limits the amount of money a lender may require the borrower to hold in an escrow account for payment of taxes, insurance, etc. The RESPA statute and regulations do not actually require the lender to maintain a cushion, which sometimes lenders claim it does. However, the RESPA allows lenders to maintain a cushion equal to one-sixth of the total amount of items paid out of the account, or approximately two months of escrow payments. Note: if state law or mortgage documents allow for a lesser amount, the lesser amount prevails! For our sample escrow account with its lowest -$840 in December, the cushion will be: $840 (to make sure the balance does not drop below zero) plus $280 (1/6 of the total escrow charges, i.e. 1/6 of $1680 = $280) = $1120. The cushioned balance will look like this:

In this example, $1120 is the maximum amount the lender is allowed to require in the account. The account should fall to the cushion at least once during the year. In this example, it happens in December ($280).

• Note that the next year’s payments can be different. There is always a chance that some taxes and/or insurance premiums will go up with time and the lender will need more funds to cover the rise. Naturally, you will be the one to provide the money. Thus, even if your mortgage is a fixed rate mortgage with what you expect to be quite even payments, the actual amount of money you will have to pay each month can change because of the escrow. If taxes rise, you should expect an unavoidable rise in the payment. And the sooner you find out about it and take action, the better. A long delay in the payment adjustment may cause the escrow account balance to drop too low. If that happens, you will have to face a larger rise of payment than what it would have been had it surfaced earlier. For that matter, the RESPA requires the lender to provide initial and annual escrow account statements. Do make sure you get one. But for the “good to know” feel, it is your proof in any legal procedure should you find out something is wrong with your escrow account. You always need to check with the other party, too – the tax office, the insurance company, etc. – to make sure their bills are paid accurately on your behalf. You may also try to reschedule the issuing of the statement with your loan servicer – depending on the time of year you take out your mortgage loan, the annual escrow analysis date can be changed, so that your payments could be adjusted more efficiently to reflect insurance premium and tax increase more quickly.
• A similar to the described above situation may occur as a result of the lender’s selfish desire to sell you a loan, even if it involves deliberate lies. Sometimes lenders offer an escrow payment that is deliberately lower than the one really required. Relying on the fact that far not all borrowers bother to check with the tax office and insurance companies about the real taxes, or make the calculations described in the tables above, lenders require a wittingly insufficient escrow payment. A sort of teaser amount, that, after a while, grows to the full size plus the compensation for the borrower’s unaware underpayment of the initial few months. That can add up to quite an amount! It’s a kind of scam that is very difficult to prove. The lender can always say that it was an honest miscalculation, plead an accidental totally unintentional mistake (which do happen sometimes), but require the high payments anyway.

Now that you are aware of the risks involved, I hope, it will be easier for you to make a decision about whether you do or don’t want to trust tax and insurance payments to the lender. It’s kind of hard to be sure in advance about whether it will or will not work with a particular lender, but you can take your time, see how it goes for a year or two, and base your choice on the result of these years. Even if everything goes smoothly and you prefer to keep the escrow with the lender, you should not relax completely – the servicing of your mortgage can be sold to some other agent any time and then you have to resume control to make sure that the new agent does not screw up.

What if you don’t want any escrows to go with your mortgage? You have to buy your way out straight away at closing or any time later. Yes, sad, but true. Freedom will cost you around 1/4 to 3/8 of a point. Escrow service is usually included into a mortgage package, and you either agree to it, or you don’t, but it is hard to find an alternative without an escrow included and good conditions otherwise.

 Why do people refinance? All for different reasons, of course, but the most common ones are:

• To obtain a lower interest rate,
• To build the equity of their property faster,
• To change the type of their loan,
• To take advantage of an improved credit rating,
• To get some cash out of the equity already built in the home.

How does it work?

Obtaining a lower interest rate is probably the most popular reason to refinance. One may have an adjustable rate mortgage with a rate gone too high, or a high-rate mortgage resulting from negative points, or an above-the-average rate caused by the poor credit score at the time of the loan origination, or it may have been a very sensible loan all the way until mortgage market interest rates dropped. Refinancing in such and such like situations can save you quite some money, but you have to be very thorough in estimating the benefit. The main question is whether the amount saved will be worth the amount paid. The procedure of refinancing is not cheap, so you have to make sure, that the money you pay for it will not only return to you, but also gain you some profit as savings on the interest, as compared with your current loan.

One of the decisive factors is the length of the remaining term of your current loan and the term of the probable new one. If the former is short, refinancing will make little sense as there will hardly be any loan that will pay off in a better way than the existing one. If the latter is too short, there will not be enough time for any real benefit to occur. Generally, there is little, if any sense, in fiddling with refinancing short term mortgages, unless the current mortgage is a total killer.

Refinancing to a shorter-termed mortgage can, however, help you build the equity of your property faster. The interest rate of a shorter-term mortgage will most likely be lower, so you will actually own more of your home every year and at a lower price. Which is good, if you can afford it, because even though the interest rate is lower, the monthly payments may well become higher, if the new term is shorter than the remaining years of the current loan: the amount of your remaining balance will have to be distributed throughout a shorter period of time. If higher monthly payments do not bother you, you may also consider regular extra principal payments to your existing mortgage as an alternative. Depending on your situation, you may be better off with just the extra payments, avoiding the trouble and the expense of refinancing altogether. Use this refinancing calculator and this extra payment calculator to compare the options. The lower interest rate of a new mortgage will cut down the amount you can deduct from taxes as interest payments; extra principal payments to the existing loan have an indirect effect on the tax deductible amount – as the balance of the loan goes down faster, the amount paid towards interest (a percentage of the remaining balance) decreases faster, too. This latter decrease, however, usually compensates for whatever tax deductions. These are my general considerations, though, meant to draw your attention to the issue. The calculators mentioned above give you a concrete idea of the tax consequences.

Some homeowners prefer to refinance their adjustable rate mortgage to a fixed rate mortgage when interest rates fall. A lot of people take out adjustable rate mortgages during periods of high interest rates because the rates of the early years of adjustable rate mortgages are lower. The rates adjusted later, however, can become pretty high, and if there happens to be an overall drop in mortgage interest rates, it may become advantageous to switch to a fixed rate mortgage. Catch the right moment to refinance and enjoy the stability and comfortable predictability of a fixed rate mortgage.

If you are refinancing to get a loan that recognizes your improved credit status, you may want to call a credit bureau to get a copy of your credit report and make sure everything is reported correctly, before visiting a lender.

If you have owned your home for quite some time, you may have accumulated a considerable amount of equity in the property, which allows you to refinance your existing mortgage to an amount actually higher than the remaining balance of your current mortgage. As the amount of the new loan is bigger than your debt on the current one, you will have enough funds to pay off the mortgage you have now and still more to use for, say, your children’s education, or home improvements, or to repay other debts. “Cash-out” refinancing normally allows you to re-mortgage up to 90% of your property value. If, for instance, the value of your home is $200,000 and the current balance of your mortgage is $100,000, you can refinance to an amount equal to 90% of $200,000, i.e. to $180,000 and use $100,000 to repay the old mortgage. The remaining $80,000 cash can be used for whatever purpose you will find for it, and it’d better be a good one for the price. Which is..? Well, first of all, after all the years of repaying your debt and building equity in your home, you are going to lose most of it and start all over. A lot of people find it hard, as owing the place you live in does give you this secure feeling of home, sweet home. It is a kind of hard to wake up in the morning and realize that today it actually is not as much yours as it was yesterday. Moreover, apart from all the regular refinancing fees, you may have to face such additional monthly payments as PMI premiums.  If over 80% of the home value gets to be mortgaged, it triggers the obligatory PMI. If over 90% of the property is mortgaged the conditions can be highly unfavourable, so do not rush into such offers, no matter how easy the broker makes them sound. Don’t let anyone talk you out of your home. Always compare different offers, gather and study all the relevant information thoroughly before you agree to sign. Remember, this money is not a gift; it is your big debt that you will have to be repaying from the day on.

If the purpose of your refinancing is mainly raising some cash, you may also consider taking out a second loan of some sort instead, or refinancing into a Piggyback loan to avoid PMI. However, when you compare these two-loan options with “one-to-one” cash-out refinancing, don’t forget to take the non-financial issue into account, too. Even if the maths of the deal makes the second or the piggyback loan more attractive, there are still a couple of non-numeral variables in the equation: having a second mortgage (even a piggyback version of it) makes it practically impossible for you to qualify for any other loan should a need for it arise; the lack of proper subordination arrangement for the second loan may make it impossible for you to refinance the first loan later.

A separate big issue is prepayment penalties on both the old mortgage and the new one. As refinancing means paying off your current mortgage before its original term is over, you may have to face a penalty for the early repayment. It is not always the case, though. You have to check your contract and every supplementary note that comes with it, and see if you are in for the penalty on the day you are planning to refinance. With most lenders the prepayment penalty applies only to the first several years of a mortgage and will probably cause no problem at a more advanced stage. Penalties on the new mortgage can be rather painful, especially if you are refinancing into a mortgage, whose other terms are not exactly very friendly either. Sometimes circumstances make people go for such loans, but everyone wants to get rid of them as soon as possible, so make sure that your new contract will not include anything that may hinder you from doing so at the time you are ready.

Points are quite a useful tool helping a borrower to lower the interest rate on his mortgage loan. The price of one point equals to 1% of the amount you borrow. If you pay this 1% amount in cash at the loan origination, the interest rate of your loan will drop by usually 0.25 percentage points. Each new discount point bought lowers the loan interest rate by another 0.25 percentage points. Thus, a 7% original rate can be reduced to 6.5% by buying 2 points. Sometimes the 0.25 percentage points off the rate become pricier if you go for more than 2 discount points. The lender may require that you buy, say, 3.5 discount points to reduce a 7% rate to 6.25%.

You cannot buy your interest rate totally out, though. Usually lenders offer several combinations of the rate and points for you to choose from.  If you see a 7% and 2 points offer in an ad, it is not very likely to be the only option available. All you have to do is ask.

Even though the idea of discount points looks rather attractive, I find it important to draw your attention to a number of subtle matters involved, and help you avoid any financial losses that may occur if the points get to be applied inappropriately.

As I have mentioned before, points have to be paid for in cash. If you are low on cash at the time of the loan origination, do not buy points, first make sure you have enough cash for an at least 20% down payment. Avoiding PMI is a lot more important!

The calculator can help you estimate whether points can be any use for you at all. Even though they do reduce the rate, the price of this reduction is pretty high. The points are not cheap and you have to make sure they are worth the money. The key to this estimation is the break-even period – a period of time by the end of which the amount you have paid for the points and as monthly payments becomes equal to the amount you would have paid as monthly payments if you had not bought any points. This is the break-even point. Only after this moment the points will start to really save you some money. The length of the break-even period usually varies around 3-4 years, which brings us to the bottom line of the paragraph – buying points only makes sense if you are sure that you will keep this particular mortgage longer than that. Long-term Fixed Rate Mortgages potentially have the best return on points.

Points bought for a short term Fixed Rate Mortgage may yield some return, too, depending on how long you stick to it. Buying points for an Adjustable Rate Mortgage is usually a less wise choice. The rate you buy down will hold only during the initial period, i.e. until the first rate adjustment. The advantage that you do get, though, is that the lower initial rate determines a lower maximum rate, if the overall maximum rate cap of your Adjustable Rate Mortgage is a value relative to the initial rate, as opposed to an absolute one. And for that matter, there’s been a word around of lower point prices on short initial rate period Adjustable Rate Mortgages. The break-even rule holds for Adjustable Rate Mortgages, too, but it is harder to estimate, because of the changing indexes and rates.

The usually painful question of taxes proves to be quite significant and still painful in regard to points, the effect they have on the interest rate, and consequently, the amounts paid towards interest. Interest payments, as well as point payments, made in a given year are deductible in that year. On a purchase transaction, points are deductible in the year of purchase, but on a refinancing, points must be deducted over the life of the loan. There are other regulations about the deductibility of points that are explained on the IRS web-page. However, each case is unique and requires special attention, consideration and professional advice.

One general rule holds, though: the lower the interest rate > the smaller the amount of money paid as interest > the lower the amount you can deduct from taxes.

Now, the last, but not the least – negative points (also called “rebates”). This is the way points work the other way around: the lender pays some of the closing costs for you in exchange for a higher interest rate on your loan you have to accept. Negative points can become your (rather expensive though) way out of a situation, when you cannot afford paying all the mortgage closing costs yourself. It is, I’d say, quite a desperate and costly measure. I wouldn’t recommend resorting to it, unless it is really necessary. If you got yourself into a mortgage with negative points, try to get rid of it as soon as possible. Do not wait until the overcharged interest rate depletes your funds.

And always remember – you are not obliged to buy any points. They are just an option provided for your convenience if you want it that way. Nobody can make you buy any points if you don’t feel like doing so.