There are a number of different components to your monthly mortgage payment. Typically, the two big ones are principal and interest. If you escrow, you may also have a portion of your payment going towards taxes and insurance. Depending on your type of loan and down payment, you may or may not be required to escrow for your taxes and insurance. Since your mortgage investor has a lien on your property it is essential that the property taxes are paid and insurance is maintained to protect the home; this is why an escrow account is established and funded by a portion of your monthly payment. Your escrow account has a lot of benefits and advantages, it’s also important that you know how it works.
What is an Escrow Account?
An escrow account is a financial account that collects funds in order to pay specific obligations that a financed home requires. If you decide to, or are required to escrow for taxes and insurance, a portion of your monthly payment will be allocated to fund this account, with the balance being used to pay property taxes, homeowner’s insurance, and possibly mortgage insurance. It may be helpful to think of it as a savings account for insurance premiums and property taxes, managed by your mortgage servicer.
How is an Escrow Account’s Balance Determined?
Your mortgage escrow’s required balance, and subsequently your monthly mortgage payment is determined by your property taxes and insurance premiums.
- Property taxes are local real estate taxes based on the jurisdiction in which the property is located. These taxes are paid on certain intervals to a parish, county, city, or other entity.
- Mortgage insurance is typically required for FHA, USDA, and conventional loans if you have less than 20% in equity.
- Homeowner’s insurance is required in order to repair, rebuild, or replace the home in case of a fire, flood, or other damage. This insurance policy will also cover any accidents or other liability issues that occur on the property.
- Flood insurance may also be required if you are located in a flood zone.
The total cost of these items is divided by 12 and added to your monthly mortgage payment to fund your escrow account. As the taxes and insurance premiums become due, your mortgage servicer will remit payment on your behalf from this escrow account.
What is an Annual Escrow Review?
Since property taxes and insurance costs may fluctuate from year to year, your lender will perform an annual escrow review. This review of your escrow account (including the previous year’s payments in the account and distributions made from the account) determines if your escrow account has a shortage or a surplus as well as if your monthly escrow payment needs to be adjusted for the upcoming year. You will receive a copy of your escrow account review/analysis and it will determine if your payment will remain the same, increase, or decrease for the upcoming year.
Should your escrow obligations decrease, you’ll have an overage in your account, and depending on the amount, those funds will be returned to you. Should your insurance or taxes increase, your escrow account will have a shortage. If this occurs you’ll have to make up the difference. Your lender will advise you on the different options to pay for the shortage. Typically, you can either make up the shortage with a one-time payment or pay it over time.
What are the Benefits of an Escrow Analysis?
While an escrow account and its payment allocations may seem like an added expense, it is a necessary part of your mortgage. It also comes with some benefits. Instead of having a property tax bill at the end of the year that must be paid, it has been divided into 12 smaller amounts. Furthermore, you don’t have to actually make the payment to your county, parish, or city; your lender will pay it directly from your escrow account. The same is true for any insurance premiums. With your escrow account, you can be confident that your property taxes and insurance premiums will be paid on time.
Property taxes and insurance are an essential part of homeownership and your mortgage. Your lender will help you to understand how escrow works and how it will affect your monthly payment. For over 90 years the expert staff of loan officers at Standard Mortgage have been helping people find the right solutions for their mortgage needs.