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Ask Dr. Don

Escrow accounts and refinancing

Dear Dr. Don,
I bought a house recently and want to refinance to take advantage of the lower rates.

At the closing, the sellers had some money held over from them toward their taxes, and portions of my payments are kept in an escrow account. How are the escrow accounts for my property tax and homeowners insurance handled when I refinance?

I've read all about closing costs and total costs, but I can't find any information on this subject. Do I have to pay in advance for my property taxes again and get a refund from my old mortgage holder? Also, I have a second mortgage on the house (to avoid PMI). Can I refinance the second mortgage as well?
Confused Refinancier

Dear Confused,
The holder of the second mortgage is unwilling to be made any worse off by you refinancing your first mortgage. That means that your new first mortgage can't be any larger than the outstanding loan balance on the existing first mortgage, and the second will have to sign off on the refinancing.

No one likes paying private mortgage insurance, but an 80-10-10 or similar financing structure won't always be less expensive than rolling the two loans into a new first mortgage. It depends on the rate differential between the first and second mortgage, your home's appraised value and the size of your down payment. PMI isn't forever, it just seems that way.

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I don't know how recently you financed your current loans, so make sure that there aren't any repayment penalties on the mortgages.

Unless you're refinancing with your current lender, you'll have to come up with cash at closing to fund the escrow account for property taxes and insurance. You'll get your money refunded from the old escrow account. The refund check should approximate the amount that was required at closing.

Take out a short-term loan if you need to, but try to avoid capitalizing (borrowing) these costs in the new loan amount. If you do capitalize these costs, use the escrow refund check to make an additional principal payment on the loan.

Read this Bankrate feature to learn about proposed legislation that would require the old lender to return your escrowed funds in seven to 21 days.

-- Posted: Aug. 5, 2002

Read more Dr. Don columns
See Also
Is your refi rate as good as new?
Cash-out refinancing vs. home equity loans
Financial advice glossary
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