What is an escrow account?

Short Answer:

An escrow account is an account that is created with your mortgage to collect and disburse payments related to real estate taxes and homeowners insurance. Every month, as part of your mortgage payment, 1/12 of the annual real estate tax bill and homeowner's insurance premium will be placed into the account. The mortgage servicer will disburse funds from the escrow account to pay the annual real estate tax bills and homeowner's insurance premiums. By law, if flood insurance is a requirement for your mortgage, it will be collected and disbursed from your escrow account.

Longer Answer:

Last week, one of my clients asked if they would be required to make real estate tax and insurance payments outside of their mortgage payment annually. I said, "no, you are making those payments monthly with your mortgage payment and those payments will be disbursed from your escrow account." The client inquired if a escrow account is like a savings account. My response was "somewhat, but without be paid interest on that money."

A mortgage escrow account is a specialized financial arrangement used by home mortgage lenders to manage and disburse funds for property-related expenses such as property taxes, homeowners insurance, and flood insurance. This account helps ensure that these critical expenses are paid on time, thereby protecting both the homeowner and the lender from loss of the property.

Why is an escrow account needed?

Most Americans are terrible savers. While most Americans HAVE a savings account; only 44% of US households reported being able to cover an unexpected $1,000 expense in December 2023. Annual real estate taxes and homeowner's insurance premiums are two large lump sum bills, the average homeowner has to pay every year. Without an escrow account, the homeowner would have to 1) save for these bills and 2) pay them on time. Failure to pay a homeowners insurance premium could mean a lapsed policy and no coverage for a house in case of damage. Similarly, not paying real estate taxes could result in back owed taxes, eventual tax liens, and possible foreclosure on the property. Any of those events put the bank's mortgage lien in jeopardy; which is why escrow accounts are set up for people's mortgage. It ensures that real estate taxes and insurance premiums are paid on time. 

How Does a Mortgage Escrow Account Work?

1. Monthly Payments: When you make your monthly mortgage payment, a portion of that payment goes into your mortgage escrow account. This portion is specifically allocated for property taxes and insurance premiums.
2. Fund Accumulation: Over time, the funds accumulate in the escrow account. The lender calculates the amount needed to cover these expenses for the year and divides it by 12 to determine the monthly escrow payment.
3. Payment of Expenses: When property taxes and insurance premiums are due, the mortgage servicer uses the funds in the escrow account to pay these bills on your behalf.

Why Do Lenders Require Mortgage Escrow Accounts?

1. Risk Mitigation: Lenders require escrow accounts to mitigate the risk of property tax liens or lapses in insurance coverage, which could jeopardize their investment.
2. Budgeting Assistance: Escrow accounts help homeowners budget for large, infrequent expenses by spreading the cost over 12 monthly payments.
3. Timely Payments: They ensure that property taxes and insurance premiums are paid on time, avoiding penalties and lapses in coverage.

Benefits of a Mortgage Escrow Account

1. Convenience: Homeowners don't have to worry about saving for large, lump-sum payments for taxes and insurance. The lender handles these payments on their behalf.
2. Peace of Mind: Knowing that your property taxes and insurance premiums are being paid on time can provide peace of mind and reduce financial stress.
3. Avoiding Penalties: Timely payments help avoid penalties, interest, and potential legal issues related to unpaid property taxes or lapsed insurance coverage.

Potential Drawbacks

1. Overestimation: Lenders may overestimate the amount needed for taxes and insurance, resulting in a surplus in the escrow account. While this surplus is usually refunded, it can tie up funds unnecessarily.
2. Underestimation: Conversely, if the lender underestimates the amount needed, you may face a shortage and need to make up the difference, potentially resulting in higher monthly payments.
3. Lack of Control: Some homeowners prefer to manage their own property tax and insurance payments, rather than relying on the lender to do so.

Annual Escrow Analysis

Lenders are required to perform an annual escrow analysis to ensure that the correct amount is being collected. This analysis compares the amount collected with the actual expenses paid. If there is a surplus, the lender may refund the excess amount. If there is a shortage, the homeowner may need to make additional payments; either a lump sum or an additional amount with their monthly mortgage payment.

Conclusion

A mortgage escrow account is a valuable tool that helps homeowners manage property-related expenses more effectively. By spreading the cost of property taxes and insurance premiums over 12 monthly payments, escrow accounts provide convenience, peace of mind, and financial stability. Understanding how your mortgage escrow account works can help you better manage your finances and avoid potential pitfalls.

Have additional questions about mortgage escrow accounts, I am happy to answer them. Reach out to me at teamjd@mainstreethl.com

—

This blog is for informational purposes only. Make sure you understand the features associated with the loan program you choose, and that it meets your unique financial needs. Subject to Debt-to-Income and Underwriting requirements. This is not a credit decision or a commitment to lend. Eligibility is subject to completion of an application and verification of home ownership, occupancy, title, income, employment, credit, home value, collateral, and underwriting requirements. Not all programs are available in all areas. Offers may vary and are subject to change at any time without notice. Should you have any questions about the information provided, please contact me.

Find more answers to questions at www.jdanswersquestions.com