Today, Dr. Don explains no-doc mortgages and the purpose of escrow accounts.

No-doc mortgages

Dear Dr. Don,
I am looking for information about no-doc loans. I would like to know what they are and how you qualify for one.
Christina Nofuss

Dear Christina,
The Bankrate.com definitions of mortgage terms page defines no-doc loans as follows: "No-documentation or low-documentation loans are designed for the entrepreneur or self-employed, for recent immigrants with money in foreign countries or for borrowers who cannot or choose not to reveal information about their incomes. You need a substantial down payment, excellent credit history and will usually pay a higher interest rate."

Using a search engine and the keywords no documentation mortgage, I was able to find dozens of financial institutions offering no documentation mortgage loans. One was even willing to loan with only 5 percent down. Remember that as the lender's risk increases, so will your interest rate. Make sure you are provided with a list of all of the costs and fees associated with the loan, and use the annual percentage rate (APR) on the loan to shop rates among lenders.

Escrow accounts

Dear Dr. Don,
I have a couple of questions regarding escrow accounts. Is a mortgage escrow account required for property taxes and insurance? If it is required, is there a time when the escrow account can be canceled? Are the monies held in the escrow account earning interest? If not, can you request that it be an interest-bearing account? Our original lender told us we could cancel the escrow account on our loan, but the loan was purchased by another lender who now says we cannot cancel our escrow account. How is this possible? I live in Illinois and my mortgage lender is in Texas.
Kim A. Kount

Dear Kim,
Escrow agreements are usually required when the loan-to-value is more than 80 percent at closing.

Escrow agreements aren't like private mortgage insurance (PMI), which can be canceled when the loan-to-value is paid below 80 percent. About a quarter of the states require that the lender pay interest on money held in escrow.

Escrows can be a useful tool for cash budgeting. You spread the property taxes and insurance expenses over the year. The lender is required to take advantage of any early payment discounts. So what does it cost you? Let's say your annual expense for taxes and insurance is $10,000. A two-month cushion would have your account's minimum balance at $1,667 and your account's maximum balance at $11,667. Your lost interest income for the year, assuming a 5 percent savings rate and a 33 percent tax rate, is about $210 after taxes. (Pro-rate this to estimate your lost interest income.) That sounds like a big opportunity cost until you consider what happens if you don't adequately budget for these expenses and end up having to borrow to pay the taxes and insurance or miss any early payment discounts.

It's difficult to get a lender to cancel an escrow requirement once it's in place. If your loan has changed hands and there is nothing in the lending agreement that provides for the cancellation of the escrow requirement, you'll have to live with the new firm's decision.

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-- Posted: March 8, 2000