What Is An Escrow Account? Definition And Facts
If you’ve never made a mortgage payment before, you might not be familiar with escrow accounts. What are they, how do they work and when are they necessary?
In this article, we’ll explore the reasons why a borrower may use an escrow account to help them manage the costs that come with homeownership. Let’s take a deeper dive.
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Escrow Account Definition
An escrow account is essentially a savings account that’s managed by your mortgage servicer. Your mortgage servicer will deposit a portion of each mortgage payment into your escrow to cover your estimated property taxes and your homeowners and mortgage insurance premiums.
Escrow accounts are also known as impound accounts in certain parts of the country.
What does an escrow account cover?
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 cover water/sewer bills or one-off assessments by your local government. It does not cover homeowners association dues or supplemental tax bills.
Establishing An Escrow Account At Closing
When you close on your loan, your lender will collect enough funds to establish an escrow account.
Each month, a portion of your mortgage payment will go into your escrow account, and your mortgage servicer will use that money to pay your taxes, mortgage and homeowners insurance bills when they are due. This spreads the amount over 12 months, making it easier on your bank account. And since your servicer is making the payments, you won’t have to worry about remembering when they’re due.
Your mortgage servicer is the company that you make your payments to. This may or may not be the same as the lender you closed your mortgage loan with.
When Do You Need An Escrow Account?
Whether you need to have an escrow account can depend on your type of mortgage, the amount of equity you have and the requirements of your lender.
Government-backed loan options, like FHA and USDA loans, require a mortgage escrow account. Lenders of conventional loans can also decide if an escrow account is necessary.
Even if an escrow account isn’t necessary, it’s still a good idea to use one, especially if you’re a first-time home buyer. 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.
When you have an escrow account, your 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 will estimate the amount to be paid for your real estate tax and homeowners insurance bills. This estimate, provided during closing, is based on the taxing authority and homeowners insurance company or previous tax and insurance bills.
Each year, your mortgage servicer will analyze your account to make sure you’re paying the right amount to maintain the minimum required balance. Because it’s based on an estimate, the amount can be overestimated or underestimated. This is called an escrow shortage or overage.
If there’s an overage, you’ll get your money back with a refund. If there’s a shortage, you’ll typically have a couple of options to pay the remainder.
Your first option is to pay the full shortage upfront. 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 servicers. At Rocket Mortgage®, clients have both options for paying off a shortage.
One more thing to keep in mind: If you have a shortage, the amount you pay for escrow each month is still going to go up because the payment is recalculated based on the new amount for taxes and insurance shown in your escrow analysis.
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How Does Escrow Work When Buying A House?
When you make an offer on a house, you’ll typically include a personal check for 1 – 2% of the purchase price, although it can be higher depending on the market and the custom in the area. This is called “earnest money” and shows the seller of the home that you’re a serious buyer. The check won’t be deposited until the seller accepts your offer.
If your offer is rejected, you’ll get your money back. Otherwise, when 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 where the money sits until all paperwork is finished and the home is officially yours.
Escrow Account FAQs
Now that you have the basics, here are the answers to some questions that might still come to mind.
Can you have an escrow account without a mortgage?
Even without a mortgage, homeowners will still have to pay their property-related taxes and homeowners insurance. If you’ve purchased a home without a loan or paid off your mortgage, it’s still possible to arrange an escrow account to help manage your property taxes and insurance premiums. You would just open a bank account and make payments into it each month to be used when the bills come due.
How do you remove your escrow account from your mortgage?
Depending on your loan type, down payment amount and credit history, your mortgage lender may require you to use an escrow account. Borrowers who opt for an USDA, VA Streamline Refinance or FHA loan, for example, are required to fund an escrow account as part of their monthly mortgage payment.
Should you meet the requirements of your mortgage servicer, you may opt to cancel your escrow account. Start by sending your servicer a formal, written request to cancel your account. If your mortgage servicer approves, the escrow company will then send you the remaining balance in the form of a check. At Rocket Mortgage, the cancellation requirements vary by loan type.
For conventional loans backed by Fannie Mae, you can’t have a payment 30 or more days late in the past year or 60 or more days late in the past 2 years. Additionally, you have to have more than 20% equity in your home. Finally, the loan has to be at least a year old.
If your home loan is backed by Freddie Mac, you can’t have a payment that’s 30 days late in the past 6 months and you must have more than 20% equity. Home Possible® loans and those that are 2 to 4-unit properties can’t have their escrow accounts removed. Again, the loan has to be at least 12 months old.
In order to have escrow accounts removed, those with VA loans must have at least 10% equity. You also can’t have a 30-day late payment in the past year. The loan has to be at least a year old.
There are other factors that impact whether your escrow account can be removed across loan types. For example, a modification can affect whether you can do it. Additionally, if you defaulted on a tax or insurance payment after receiving an escrow waiver before, you won’t be able to get an escrow waiver. Finally, if you do miss a tax or insurance payment, Rocket Mortgage will put your escrow account back in place.
Requirements can also vary depending on the state you live in. If you have questions, contact your servicer.
Do escrow accounts earn interest?
In general, banks and other servicers are not required to generate interest on money held in escrow accounts. That’s why some homeowners may cancel their escrow account and move their money into a savings account with an interest rate. They can still use the account to pay the insurance and property taxes while collecting interest on the remaining balance.
Can you change your homeowners insurance when you have an escrow account?
Your existing escrow account will not impede your ability to shop for new homeowners insurance coverage. In fact, finding a cheaper insurance plan could be a great idea if you’re worried about an escrow shortage.
To avoid a lapse in coverage, make sure to sign on with your new insurance provider before you cancel your current homeowners policy.
Additionally, when you switch homeowners insurance companies, be sure to send your refund to your mortgage servicer to help avoid having to pay off a big shortage later on. The reason for this is that your lender pays upfront for your insurance policies when they come due to be covered for the following year. Here’s some more information on switching homeowners insurance companies.
How do you keep track of your escrow account balance?
Since escrow accounts are managed by a third party – such as an escrow agent or your mortgage servicing company – are homeowners able to review the details of their accounts? The answer depends on your lender, but in general you are entitled to your account information.
In the event that you’d like to view your escrow payment history or current balance, many mortgage servicers provide online access portals. Others may request you get in touch with the bank directly. Speak to your mortgage servicer to learn the best way forward. Rocket Mortgage clients can access their escrow information online.
The Bottom Line: Monthly Escrow Payments Can Give You Peace Of Mind
When buying a house, opening an escrow account is an important part of the process. Depending on your type of loan, it may be required. An escrow account can also offer peace of mind as it provides protection and a convenient solution for paying your taxes and insurance.
If you’re looking to buy a home and are ready for the next step in the process, get started online today with Rocket Mortgage.
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