How do I make sense of mortgage escrow accounts?
For first-time homebuyers, the process of securing a mortgage typically introduces a dizzying array of new terminology—including “escrow accounts”. But what does this even mean? Chances are, you’ll need to get acquainted with this financial arrangement, so read on and learn…
Mortgage Escrow Accounts for Homeowners
A mortgage escrow account is the account that the lender uses to pay your property taxes and homeowners insurance on your behalf. Often it is a choice of whether or not you would like to escrow, but in some cases it is not. Most people who have the option do choose to have one, but some people might opt out.
Wait, they pay for my taxes and insurance? Hold on there a minute. Yes, the lender pays these on your behalf--with your money--for as long as you have the mortgage loan. The next section explains why this is beneficial and how it works:
Property Taxes Property taxes are generally billed from once to several times per year. To help you manage the large lump-sum payments that are property taxes, the lender will use an escrow account to break down your tax payments into 12 monthly payments. This makes your tax payments more manageable and ensures that they will be paid on time. Lenders are keen to ensure that you keep up with your taxes, as failure to pay them can result in a tax lien or foreclosure…and well, no one wants that.
When you make your monthly mortgage payment, there is a portion added to that payment for your escrowed taxes. The escrow account collects this money monthly from your payments and grows the account accordingly. When taxes are due, the lender or loan servicing company will pay the taxes directly on your behalf. Each year, the lender re-evaluates the needed set-aside according to the latest tax assessment amount, and may adjust your payment accordingly. This is known as an annual escrow adjustment or balancing.
Homeowners Insurance Similarly, homeowners insurance premiums are typically included in the mortgage escrow account. Just as with property taxes, your annual insurance premium is broken into 12 equal monthly payments. That monthly amount is added to your monthly mortgage payment, and the insurance payments are sent directly to the insurance company on your behalf when they are due. Here, too, the lender makes adjustments to the payment amount when your insurance premium changes.
Keep in mind, if you have a shortfall in your escrow account, you may be required to pay it in order to ensure that your taxes and insurance are fully funded. Alternatively, the amount of the shortfall may be prorated and added to your payments throughout the next year.
Under certain circumstances, a borrower must carry a mortgage escrow account. Generally these circumstances are limited to the following:
FHA or VA mortgages If you take out a mortgage under the FHA or VA program, you must escrow your taxes, insurance, and mortgage insurance. These are simply part of the requirements set by the government entities that oversee these programs.
Private Mortgage Insurance (PMI) If your loan, be it FHA or conventional, included a PMI policy, your PMI payments must be escrowed. This typically happens when you put less than a 20% down payment on your home, meaning that your loan-to-value is above 80%. You cannot opt out of the escrow for PMI as you might with property taxes or homeowner’s insurance. The PMI can then be removed once your loan-to-value drops to 80% or below. This can happen as you pay down your mortgage, and also sometimes when your property value increases.
Flood Insurance If you purchase a home located in a flood zone A or Z, as designated by FEMA, then by law you are required to carry flood insurance. Flood insurance is a separate policy from hazard insurance and is often more expensive. Lenders don’t allow you to pay flood insurance separately and require you to have the monthly premium escrowed.
Back taxes If you own a home already, and for whatever reason, you end up in a situation where your property taxes fall behind, a lender will give you a new mortgage, (or refinance,) only on the condition that you have them paid in an escrow account. Lenders do not want a tax lien placed on your property, as it can disadvantage you both. In fact, if you have a loan without escrows and your lender receives notice that you have missed property tax payments, the law allows them to create an escrow account on your behalf without asking your permission!
What Happens to the Escrow When I Pay Off My Mortgage?
If you are one of the fortunate enough people to be able to pay off your mortgage entirely, then congratulations! That is quite an accomplishment! And while you will be thankful to not have that monthly mortgage payment anymore, you still have to pay for your homeowners insurance… and taxes. Once your mortgage loan is paid off, your lender will return any remaining escrow funds to you. From that point on, you are responsible for paying your own taxes and insurance according to the required or agreed-upon schedule (typically annually).
To Escrow or Not to Escrow
Most mortgages today feature an escrow account. Corelogic recently found in a survey that 80% of mortgage holders have made the choice to include escrows with their mortgage payments. Most people have chosen them because keeping track of one bill that pays for 3-4 separate items is easier than handling all those various payments separately.
When they have the option, some people may want more control over the payments, as lenders occasionally may make mistakes and fail to make the proper escrow payments. Then it would fall on the borrower to get things straightened out. Similarly, for some people, it may be beneficial to wait and make the tax and insurance payments once per year as a lump sum because that’s when they earn most of their money (e.g. holiday season, annual bonus, etc.). That way, their monthly payments stay lower throughout the rest of the year. To make matters more complicated, most lenders only make 1 adjustment per year to the escrow account, and sometimes the lender is asking you to play catch up for the insufficient payments accrued over the course of the year since their last adjustment.
Whew, that was a lot of information! Still have questions? We’re here to help. Whether you are a first-time homebuyer, an experienced real estate investor, or are considering refinancing your current home loan, Simplist aims to make your mortgage process completely painless. Thanks to our exceptional array of mortgage options and dedicated loan advisors, you’ll be primed to navigate the decisions ahead. Set up a call with a licensed loan expert today!