Alex Varela • October 11, 2024

What is Escrow Advance

Understanding Escrow Advance in Refinancing: What You Need to Know

Refinancing your mortgage can offer several financial benefits, including lowering your interest rate, reducing your monthly payments, or even tapping into home equity. However, during the refinancing process, there are often costs and logistical challenges that borrowers need to navigate, one of which is handling the escrow account. Sometimes, to ensure that property taxes and insurance premiums are paid without delay, borrowers may need an escrow advance. This article explains how escrow advances work specifically in the context of mortgage refinancing.

What Is an Escrow Advance?

An escrow advance in refinancing is a prepayment provided by the lender to cover immediate costs associated with property taxes, homeowner’s insurance, or other fees that are typically paid through an escrow account. When you refinance your mortgage, your existing escrow account will be closed, and a new one is usually set up with the refinanced loan. During this transition, the lender may issue an escrow advance to ensure that all necessary payments are made on time.

This is particularly important because the escrow account is used to pay for ongoing obligations such as property taxes and insurance. Any gaps in funding or timing mismatches between the closure of the old escrow account and the setup of the new one can cause shortfalls, leading to missed payments or penalties. An escrow advance helps bridge that gap, allowing the borrower to refinance smoothly without interruptions in payment.

How Does Escrow Work in Refinancing?

When you initially take out a mortgage, your lender will often require you to contribute monthly to an escrow account. This account is used to pay for expenses such as property taxes and homeowner’s insurance. The same principle applies when you refinance your mortgage, but the process involves closing your current escrow account and setting up a new one under the terms of the refinanced loan.

Here’s what typically happens:

  • Closing the Old Account: Once you refinance, the lender will close your existing escrow account and refund any remaining balance to you. However, this refund doesn’t happen immediately—it can take a few weeks.
  • Setting Up a New Escrow Account: The new loan comes with its own escrow account, and you’ll need to fund this account to ensure that your future property tax and insurance payments are covered.
  • Paying Immediate Expenses: There might be property taxes or insurance premiums due between the closing of the old escrow account and the setup of the new one. If your new account doesn’t have sufficient funds right away, an escrow advance may be necessary to cover these immediate expenses.

Why Are Escrow Advances Needed During Refinancing?

The need for an escrow advance arises due to the timing issues involved in closing one loan and starting another. Here are a few reasons why escrow shortfalls can occur during refinancing:

  1. Transition Period: When you close on your refinanced loan, there’s often a delay between the closure of the old escrow account and the full setup of the new one. This can result in a gap where there isn’t enough money in the new escrow account to pay taxes or insurance premiums that may come due during this period.
  2. Property Tax Due Dates: Property tax deadlines don’t align with your refinancing schedule. If property taxes are due right before or after you refinance, there may not be sufficient funds in the new escrow account to make the payment on time, triggering the need for an advance.
  3. Refund Delays: While your old lender is required to refund any remaining escrow balance after the loan is paid off, this process can take several weeks. In the meantime, bills like property taxes and insurance still need to be paid.
  4. Increased Costs: In some cases, the amount needed for taxes or insurance may have increased since the initial setup of the old escrow account, leading to an immediate shortfall when the new escrow account is created.

Benefits of Escrow Advances During Refinancing

Escrow advances during refinancing can offer several benefits for homeowners looking to streamline the process:

  • Prevent Missed Payments: Refinancing is meant to improve your financial situation, but missing a property tax payment or insurance premium can cause penalties or lapses in coverage. An escrow advance ensures that you remain up-to-date on these essential payments.
  • Avoid Large Upfront Payments: Setting up a new escrow account during refinancing typically requires a lump-sum payment to cover several months of taxes and insurance upfront. An escrow advance can help manage this cost without requiring an immediate out-of-pocket payment.
  • Smoother Refinancing Process: For many borrowers, the refinancing process is already complex enough. By utilizing an escrow advance, you can ensure that everything is handled behind the scenes, without having to worry about missed payments or delays in setting up the new escrow account.

Common Scenarios for Using an Escrow Advance in Refinancing

Here are a few scenarios where an escrow advance can be particularly helpful:

  1. Property Taxes Due Immediately After Refinancing: If your property taxes are due shortly after you close on your refinance, and your new escrow account doesn’t have enough funds to cover the bill, your lender may issue an escrow advance to ensure the payment is made on time.
  2. Delays in Refunds: When your previous lender closes your old escrow account, it may take several weeks to receive your refund. During this time, bills such as property taxes or insurance may be due. An escrow advance can help cover those payments until the refund arrives.
  3. Insurance Premiums Coming Due: Similar to property taxes, if your homeowner’s insurance premium is due soon after you refinance, an escrow advance can ensure that your insurance remains current, preventing any lapses in coverage.

Managing an Escrow Advance After Refinancing

If you receive an escrow advance during your refinancing, it’s important to understand how repayment works. Typically, the amount of the advance will be added to your new escrow account, and you’ll repay it over time through your monthly mortgage payments.

In some cases, your monthly escrow contributions may increase slightly to cover the advance. This is a manageable way to ensure that all your obligations are met without needing to pay large sums upfront.

Conclusion

Escrow advances can be a valuable tool in the refinancing process, helping to smooth over any financial gaps that may arise during the transition from one loan to another. They provide peace of mind by ensuring that your property taxes and insurance premiums are paid on time, even when your old escrow account is closed and your new one is still being set up. By understanding how escrow advances work and when they’re needed, you can navigate the refinancing process with confidence and avoid any unnecessary complications.

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By Alex Varela • December 13, 2024
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By Alex Varela • November 29, 2024
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Alex Varela in a blue suit is standing in front of a wooden wall that reads

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