Tom Kelly

With mortgage interest rates ticking lower, borrowers are looking at the possibility of refinancing their loans and enjoying the comfort of lower monthly payments.

According Freddie Mac’s Primary Mortgage Market Survey, interest rates on home loans have ticked down in six of the past eight weeks. While this has been good news for owners, some lenders have built in safeguards that might come as a surprise.

In the past few months, more explanation has been necessary at closing regarding prepayment penalties on home loans. That’s because some lenders are requiring a “soft prepayment penalty” or “soft prepay” clause to discourage borrowers from quickly refinancing their loans as soon as interest rates drop.

The “soft” limitation allows the borrower to prepay the loan without penalty only if the home is sold. However, if the loan is refinanced during a specific period of time, typically three to five years, the borrower faces a prepayment penalty that could amount to thousands of dollars.

Some escrow agents have sent out prepayment penalty figures to sellers on preliminary closing statements. In some cases, it has taken some time and effort to locate the “soft” prepayment document, allowing the seller to sell without penalty. Dealing with this on a deadline, especially if you happen to be out of town, can be frustrating and confusing.

To better explain where this might happen, let’s step back and look at escrow. Escrow is an arrangement in which money and/or a third party on behalf of the buyer and seller holds documents. The purpose of escrow is to ensure that all parties to the deal are satisfied. Escrow ensures the seller receives the purchase price, the buyer receives clear title to the property and the lender gets the proper security interest in the property.

Most escrow agents say they only work off the numbers given to them in writing by the lender. Good escrow agents do not take verbal figures. If the escrow actually paid the wrong amount, it would most likely be up to the escrow agent to resolve the problem. Escrow also enables the parties to avoid face-to-face contact during the deal. This is often a highly emotional time when all parties don’t necessarily agree on all conditions – things such as work orders, loan charges and the condition of the property.

Escrow may be “opened” by either buyer or seller and typically occurs when the real estate agent delivers a copy of the purchase and sale agreement to the escrow agent. Escrow can technically open when the lender delivers a copy of the loan commitment to the escrow agent.

An escrow agent may be a bank, some other financial institution, a title insurance company, an independent escrow firm, a mortgage broker or an attorney. While requirements in certain states may differ, here are the common ingredients most often required for a successful escrow:

A written deed. Real estate cannot be transferred orally.

An enforceable contract. This is typically a purchase and sale agreement, commonly known as an earnest-money agreement.

Delivery. This normally occurs when deposits are placed with the escrow agent.

Escrow agent. Agreed on by both parties; often chosen by the real estate agent handling the sale.

Instructions. Details on when deposits are to be made/returned and when closing is to occur.

Conditions. Describes what conditions must be met before title and cash passes to respective parties.

The escrow agent orders title insurance and works to clear any defects or encumbrances from the title. The agent also reviews the purchase-and-sale agreement and loan commitment, collects the funds necessary to close and prepares settlement or closing documents.

The escrow fee is one of the closing costs. It is often split between buyer and seller, but the payment can be negotiated and spelled out in the purchase-and-sale agreement. The higher the sales price, the higher the escrow fee.

Closing is the consummation of the transaction – the seller delivers title to the buyer in exchange for the purchase price. The term “closing date” refers to the legal closing date, when the documents transferring title from seller to the buyer are delivered and recorded.

Once the closing documents are signed, they have to be reviewed and approved by the lender and then sent to the title company for review and recording. Once that is done, the lender issues a check or wires money to the escrow agent. The escrow agent verifies the funds are good and that the amount is correct and enough to pay all obligations.

Check to see if one of your obligations is a prepayment penalty when you refinance. It will help you plan and probably save some anxiety.