An escrow account is an account held by a third party who manages the funds. Mortgage escrow accounts are held by your mortgage lender or other escrow holder to pay your property taxes, homeowners insurance and possibly homeowners’ association fees (if you have them). Payments are made to the appropriate parties when they’re due.
Let’s discuss how an escrow account works and why it might be helpful.
What Is an Escrow Account and How Does It Work?
Why should someone else manage your money for you when it’s just easier to do it yourself? When you have a mortgage, you’ll likely have to pay for other home-related bills outside of your mortgage. Appliances break, the air-conditioner loses its will to live on a 95-degree day. Things happen.
If you have an escrow account, whoever manages the account will pay your property taxes and insurance premiums. Instead of these popping up as surprise payments, they’ll break that money down into manageable chunks rolled into your monthly mortgage payment.
How Do I Know If I Have an Escrow Account?
Your banker or loan officer would have discussed the escrow account with you as you were going through the loan process. Also, once you close your loan, your monthly billing statement shows how much of the money you paid went to your escrow account, and you get a yearly escrow analysis showing the details of the account – we’ll talk more about this below.
How Is Escrow Calculated?
So it makes sense to have an escrow account, but how do you know how much money you have to pay into it? All of your insurance and tax payments that will be made over the next 12 months are added together and then divided by 12. That number is added to your monthly mortgage payment so you only have one payment that you have to make each month.
What Is an Escrow Analysis?
An escrow analysis is conducted on a yearly basis. Because payment is due for each item at different times, some months you’ll have a lot of extra money in your account and some months you could actually have a negative balance. To make it more complicated, some types of insurance only have to be paid every three years, which can really mess up your 12-month plan.
To avoid a negative balance, your lender or escrow holder will employ certain tactics. Usually, they’ll have you put an extra two months of escrow payments, called a cushion, in your account. If, after that cushion, the 12-month forecast shows that you’ll be low one month, your escrow payment will be increased enough so that you’ll still have enough money in the account.
You want to make sure that there’s enough money in your escrow account at all times to cover your expenses. Performing an escrow analysis is how you do that. This is done once a year, but you can also request to have one done at another time.
Shortages and Surpluses
In some cases, after an escrow analysis is done, you can actually end up with a surplus or shortage in your account. This could happen if you have an increase or decrease in your property taxes due to a change in your property value. Changes also occur when you switch insurance carriers or policies.
If the analysis finds that you’ve got a surplus in the account, sweet! You’ll receive an escrow surplus check.
If you find that one of these changes causes a shortage in your escrow account, that’s where things start to get a little hairy. If you have a shortage, your escrow payments will increase until the shortage is paid off. Your new monthly escrow payment will take into account the higher taxes and/or insurance premiums.
Escrow doesn’t have to be complicated or scary once you break it down a bit – you could actually get money back from it! Did we answer all of your questions here? Ask your other escrow-related questions in the comments below.
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