How to Understand Your Escrow Account

(Property taxes, Homeowner Insurances, PMI, Reserves, Etc.)

There’s a lot of paperwork and money involved when you purchase your home. Some of the paperwork you come across will involve an escrow account. An escrow account is a way of securely holding money to be paid out in the future. Generally, your home purchase involves an escrow account.

Mortgage Related Escrow Accounts

The escrow account this is about involves your monthly mortgage payment that includes a separate account to pay some important homeowner expenses. These typically include property taxes, homeowners insurance, possibly mortgage insurance (MI), and a reserve. Almost every lender requires an escrow account. Certainly, these lenders do:

• Federal Housing Administration (FHA) loans. These loans require an escrow account.

• Veterans Administration (VA) loans. The VA does not directly require an escrow account. However, the VA does require lenders assure the home is covered by hazard insurance (homeowners insurance) and that property taxes are paid. The end result is VA guaranteed loans require escrow accounts.

• Conventional loans. This is a broad category of loans that don’t universally require escrow accounts. However, the vast majority are guaranteed by Fannie Mae or Freddie Mac, which do both have escrow account clauses. You can expect an escrow account to be required if you borrow more than 80% of the home value, which means you’ll have private mortgage insurance (PMI) included in the escrow account.

• High-cost home loans (unconventional loans). These are not typically federally guaranteed loans. The individual lenders have discretion regarding escrow accounts. Most lenders require an escrow account for at least the first five years of the loan.

Why Escrow Payments?

There are two general reasons for an escrow account. First is to assure the funds are available when periodic payments come due. Due dates for property taxes and insurance premiums don’t often match when your mortgage payment is due. Typically, these are due quarterly, semi-annually, annually, or on a different schedule. The escrow payment is collected monthly with your mortgage to assure funds are available when needed. The escrow funds go into an account separate from your mortgage payment.

The second reason for an escrow account is to keep your monthly payments stable. That property tax bill can be a whooper if you haven’t saved for it. If your semi-annual homeowners insurance and taxes are due the same month, it’s a double whammy. The escrow account makes sure the money collects monthly so that you never notice when those bills are paid.

You can find relevant escrow regulations at: § 1024.17 Escrow accounts.

Calculating Escrow Payments

You don’t need to do any of the math yourself. But it’s wise to know how your escrow payment is calculated. The basics like property taxes and homeowners insurance are relatively stable but do change over time. Like almost every other living expense, taxes and insurance premiums could go up on an annual basis. Therefore, you can expect your escrow payments to increase occasionally to keep pace with inflation. You should receive some type of Annual Escrow Disclosure Statement explaining the changes in your escrow payments.

Your mortgage company estimates your monthly escrow payment by adding up all of the expenses that will be paid from the account during a 12-month period. This normally includes property taxes, homeowners insurance, and mortgage insurance (MI). There is also a minimum balance required that is commonly known as a reserve. If you don’t understand some costs, you can contact your mortgage company for an explanation.

Your mortgage company takes the annual total and divides by 12 to arrive at the monthly charge that you pay. Your monthly principal and interest payments are added in to come up with your total monthly payment. Your monthly bill should show your mortgage payment (principal and interest) separate from your escrow payment.

Because these are estimated costs, it’s possible that your escrow account can have either a shortage or a surplus of funds. You’ll be notified by your mortgage company either way. If there is a shortage, you’ll need to pay more into escrow. It may be a onetime lump sum payment or you may be able to pay the shortage over several months. You can expect your regular monthly payment to increase going forward so that a shortage doesn’t occur again.

If there is too much money in the escrow account, you may receive an escrow surplus check instead. Lenders are required to return any surpluses over $50.

I encourage you to continue reading our blogs for more valuable information about homeownership. A blog you might be interested in is: Top Ways to Develop Money Saving Habits.

If you need more information or have questions, please contact us . You can also  reach us by calling at (678) 570-8123. We'll be glad to help you!