Learn more about your home escrow account so that you can build wealth more efficiently…
Over the years the creator of TheWealthIncreaser.com has received many questions about escrow accounts of homeowners and they all wanted a clear explanation of what escrow accounts were all about as it is rarely a subject that is explained in meaningful detail by many in the finance industry.
Let us first start by defining what a home escrow account is and then we can dive into some of the more frequently asked questions—and answers that hopefully will put your mind at ease as it relates to homeowner escrow accounts.
A home escrow account is an account that home owners have that is established with their mortgage servicer for the payment of taxes and insurance–generally.
An escrow account acts as a savings account that is managed by your mortgage servicer. Your mortgage servicer will deposit a portion of each mortgage payment that you make on a monthly or otherwise agreed basis into your escrow account to cover your estimated real estate taxes and insurance premiums.
In a nutshell, it’s really just that simple!
Your escrow account will cover regular property taxes and homeowners insurance as well as flood insurance if it’s required in your area. It does not generally cover water/sewer bills, storm water fees or other assessments by your local government. It does not cover homeowner association dues or supplemental tax bills.
It is important that you realize that your tax or insurance bill would be sent directly to your mortgage servicer and you would normally not be involved in the process. In essence, you are relieved of paying those bills directly as long as you keep the account funded at the right level and you stay current on your mortgage loan.
If you don’t have a mortgage on your home or you have a more exotic loan type—you would pay your taxes and insurance directly to your taxing authority or insurance company.
Additionally, if you own your home outright you would not be mandated to carry insurance, however your tax payments would be mandatory and it would be your responsibility to ensure that they were paid in a timely manner. It is also a good practice to carry insurance unless you can effectively “self-insure” your property.
Whether you need to have an escrow account or not will depend on your loan type and your lender. Government-backed loan options, like FHA and USDA loans, require an escrow account.
Lenders of conventional loans can decide if an escrow account is necessary!
Even if an escrow account isn’t necessary, they can still be a good idea. If you don’t use an escrow account, you’ll be responsible for paying property taxes and insurance yourself, so you’ll need to handle budgeting and paying them on time. You can simplify your “monthly finances” by setting up an escrow account if your mortgage servicer allows you to do so.
When you have an escrow account, your lender or mortgage servicer manages the payments and budgeting for you, and you’ll be able to spread out your taxes and insurance payments over the year, instead of paying a lump sum all at once.
How Escrow Analysis Works
Your mortgage servicer and/or lender will estimate the amount that will have to be paid for your real estate tax and homeowners insurance bills. This estimate, provided during closing and often adjusted in future years, is based on the taxing authority and insurance company, or previous tax and insurance bills of the previous homeowner.
Each year, your mortgage servicer will analyze your account to make sure you’re paying the right amount to maintain the minimum required balance according to a formula. Because the formula is based on an estimate of your taxes and insurance that can change over time, the amount can be overestimated or underestimated.
This is called an escrow shortage or escrow overage in the mortgage industry!
If there’s an escrow overage, you’ll get your money back with a refund–HOORAY!
If there’s a shortage, you’ll typically have a couple of options to pay the remainder–BOO!
Your first option is to pay the full shortage up front.
Another option would be to “pay the shortage over a period of 12 months” along with your regular payment. However, this option may not be allowed by some mortgage loan servicers.
You also may pay a “partial amount” with some servicers, and your payment would go up–but not as much as stated in the communications (Escrow Account Disclosure Statement) that you would receive from your servicer.
If you chose to “pay nothing” you would in essence be choosing to “pay the shortage over a period of 12 months” and your payment would go up by a certain amount–normally the amount stated in the communications (Escrow Account Disclosure Statement) that you would receive from your servicer.
You would normally receive this notification 30 to 60 days before the monthly increase, thereby giving you additional time to decide which of the above options you would choose if allowed by your servicer.
How Escrow Works When Buying A Home
When you make an offer on a home, you’ll typically include a personal check of 1-2% of the purchase price depending on your state or jurisdiction. This is called “earnest money,” and shows the seller of the home that you’re a serious buyer and not merely wasting their time. The check would not be deposited until the seller accepted your offer.
If your offer is rejected, you’ll get your money back, however if the offer is accepted, the money will go into an escrow account to be held until it’s time to close.
Then, the money will be used toward your down payment and closing costs. In this scenario, the escrow account acts as a neutral place for the money to sit until all paperwork is finished and the home is officially yours. Although this is an escrow account it differs from the one in this discussion as the escrow account in this discussion is used primarily for property taxes and insurance of a home that has already been purchased.
Refund of Escrow
In cases where you overpay your taxes due to the servicer coming up with the wrong amount needed to pay taxes and it is over a certain amount a refund check would be sent to you by the servicer. This often happens in the early years of your mortgage but could happen later depending on your particular area and circumstances.
If you have excess funds in your escrow account you would receive a refund check based on a formula. That refund check would be a welcome surprise to you.
Payment to Escrow
In some cases you will have to make an additional payment in a lump sum or on a monthly basis to your mortgage servicer. If your taxes or insurance increased during the year or when your policy renewed–you might face a situation where you would have to pay an additional amount to bring your escrow account back up to an acceptable level.
Other Costs Associated with Homeownership
In addition to your escrow payment that includes mortgage, interest, taxes and insurance there are other costs associated with home ownership that you must budget for on a monthly basis and they include the following:
In some subdivisions or neighborhoods a “special assessment” could be put into effect for sidewalk or sewer improvements and you would possibly be responsible for a number of years depending on the improvement, the amount and your jurisdiction
In some areas and communities you may have to pay home owner fees or association fees based on the amenities in the neighborhood.
Furthermore many associations control what you can and can’t do in the subdivision such as changing your house paint color, parking on the road, assessing penalties for your failure to pay HOA dues and other control mechanisms that seek to keep the property values as high as possible in the subdivision.
You must account for utility payments such as water, electric, gas, phone and other monthly recurring costs associated with homeownership.
In some communities storm fees are assessed to homeowners and they are often outside of your water payments and escrow payments.
Rapid Fire Q and A
Q1: How does escrow accounts work?
A: Your escrow account allows your mortgage servicer to pay your real estate taxes and/or insurance premiums for you. The payments are initially made by you to your servicer and they subsequently forward the payment to the taxing authority and/or insurer.
Every time you make a monthly mortgage payment a portion is deposited in an “escrow account” that is managed by your servicer. An escrow account ensures that your bill is paid in full and on time and frees you from the task of handling those payments yourself.
Q2: Exactly what payments come out of my escrow account?
A: Your real estate taxes and/or insurance premiums. If you don’t have a mortgage you would not have an escrow account and you would pay your taxes and insurance directly!
Private Mortgage Insurance and/or Mortgage Insurance Premium (if you put less than 20 percent down at time of purchase) would also come out. Flood insurance and other fees if included on your real estate tax bill might also be included.
Q3: Where do I get the information that is needed to calculate my escrow payments?
A: Most loan servicers will project your your real estate and insurance payments based on past numbers, or information on your closing documents.
Q4: Can the amount that I pay monthly change?
A: Absolutely, it depends on the movement (up or down) of your taxes and insurance in most cases. With most servicers a review is done at least annually and any changes (increases) in your mortgage payment will be reflected on your “Escrow Account Disclosure Statement” which you would receive after the review was conducted.
Q5: If I pay too much for the year will I get a refund?
A: As mentioned earlier if you pay too much—you will receive an escrow refund—and it would be a big surprise for you—prior to your landing on this page.
If you pay too little–you would have to pay a lump sum to possibly keep your payment the same or pay more on a monthly basis–again that too would be a big surprise to you, prior to landing on this page.
Q6: How do I know if my payment calculation is accurate?
A: As to the accuracy of your payments, your mortgage company will perform calculations to ensure that there are sufficient funds. They would normally maintain a “minimum escrow balance” and under the law they may also add a small cushion in anticipation of changes in your taxes or insurance premiums. Those amounts are added to your monthly mortgage and you would pay them monthly.
If there was an overage of a certain dollar amount you would be refunded a portion. If their was a shortage you would owe an additional amount. You can do a ballpark estimate by dividing your most recent tax bill by 12. Your loan servicer will also have to keep a 2 month reserve in most cases.
Therefore, add two months to the estimate (i.e. $1,200 / 12 = $100 per month and $1,200 plus 2 months = $1,400–$1,400/12 = $117 per month estimate) and you will come up with a ballpark figure that you can use as a check.
Q7: Is a minimum balance required in my escrow account?
A: Yes, minimum account balances are governed by federal law–or by your loan contract and applicable state law.
In most cases your minimum balance (excluding PMI or MIP) will be 2 months of escrow payments unless your loan contract specifies a lesser amount.
Q8: If my payment increases, can I still receive an overage check?
A: Yes, due to the most recent estimates for the year you may receive a refund and when the taxes increase–the review by your servicer might signify an increase in your monthly payment “after” you have received your escrow refund check.
If you have an overage of $50 or more and your loan is current, your servicer would be required to send you those funds rather than “decrease” your monthly payments.
Q9: Why can’t my mortgage company apply the overage to future mortgage payments?
A: By law they must notify you if you have an overage of $50 or more and your loan is current, your servicer would be required to send you those funds rather than “decrease” your monthly payments.
If you desire to make an additional payment from the overage check you can do so, however you must cash in the check and indicate additional payment of principal or interest when you send in your monthly mortgage payment.
Q10: What options do I have if there is a shortage in my escrow account?
A: You can choose to pay the entire shortage (or in some cases a partial shortage depending on the lender) or pay the shortage over 12 months and that would increase your monthly payment.
If the additional payment amount will cause undue hardship you can contact your lender and see what can be worked out. PMI or MIP may be able to be eliminated if your property and loan meets certain conditions and that would have the effect of lowering your monthly payment. Other options such as loan modification may also be available.
Q11: Are there penalties involved if I fail to pay my shortage in full?
A: No, if you elect not to pay the shortage your monthly payment would increase but there would be no penalties or additional interest payments due.
Q12: Why did my taxes and/or insurance go up?
A: Your taxing authority possibly increased the millage rate and/or your property value increased. Your home insurance policy may have increased for this same reason–among others. Based on projections made by your loan servicer your escrow account payment would then go up in most cases.
Q13: If I get news early that my taxes and or insurance will go up can I send in additional amounts?
A: You can normally send additional escrow account payments at any time, and your taxes and insurance would be paid. If there is an overage or shortage your servicer would send you a refund or request additional funds or increase your monthly payment.
Q14: If I pay monthly by automatic draft will my new payment amount be automatically adjusted as a result of escrow changes?
A: Yes, your mortgage servicer would normally adjust your payment based on the new payment. Please ensure that you have enough money in your account to meet the new monthly payment amount.
Q15: Will my third-party payment provider adjust my payment to meet the new payment amount?
A: If you use a third party, that can be a little trickier. You may want to contact them and let them know your new payment amount that was reflected on the Escrow Account Disclosure Statement.
Q16: Can I view my escrow account disclosure online?
A: Yes, most lenders have an online dashboard portal that allows you to do so. Many lenders will also mail you an Escrow Account Disclosure Statement notifying you when your payment will increase.
Your escrow account allows your lender to pay your real estate taxes and/or insurance premiums for you.
Every time you make your monthly mortgage payment a portion is deposited into your escrow account and depending on when your taxes are due or your insurance policy renews—the money is pulled out and paid to the taxing entity(s) and insurance provider.
Whether your escrow was calculated effectively by your mortgage servicer and you are due a refund or if you may owe an additional amount, you can alleviate your fears by knowing how escrow accounts work on the front end–and planning for your future success.
You must know at the earliest time possible that taxes and insurance can rise or fall for varying reasons and it is your responsibility to know what is happening in the area in which you live. You must also know that taxes and insurance can rise or fall and that too is your responsibility to know at the earliest time–where and when possible.
To alleviate your concerns about escrow account movement be sure that you establish a properly funded emergency fund and you have a conceptual overview of your life stages that will benefit you greatly in your future.
Always consider the total cost of homeownership—prior to your home purchase. That means you must know your mortgage payment including escrow, your utility payments, yard maintenance, age of HVAC, water heater, electrical and other appliances and components of your home.
Your options will vary depending on type of loan and the fine print in the loan documents of your particular lender when all is said and done.
You now are equipped with the homeowner escrow knowledge that you need to succeed.
You now know that when market downturns occur such as the 2007/2008 housing debacle or the economic downturn that we are now experiencing due to COVID-19 there is a good chance that your mill rate and taxes will remain steady or possibly go down due to falling home prices depending on your particular home location.
You also know that if you are in an improving neighborhood that is in high demand your taxes could potentially go up!
It is your responsibility to plan on the front end for all scenarios whether an increase in taxes, insurance rates, special assessments, HOA fee increase etcetera–and it is important that you properly establish an emergency fund at the earliest time possible as you move along through the various stages of your life.
All the best toward your homeowner escrow success…
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