Any time you buy a house and secure a mortgage to finance the purchase, you will become familiar with the term ‘escrow’. However, what does escrow refer to with regard to home loans?
Escrow entails the common practice by most mortgage lenders where the borrower is expected to deposit with the mortgage lender an amount that is used to pay for property taxes, homeowner’s insurance, mortgage insurance and other charges incidental to ownership of the property. There is need to save for these expenses monthly so that the homeowner will not be defraying the amounts required for these expenditures.
How Escrow Accounts Work
When your lender determines your monthly mortgage payment, that payment is for the principal and interest on the loan plus the escrow. Every time you pay the amount due each month, the principal and interest payment is used to reduce your loan balance while the escrow amount is placed in a separate account. Your lender maintains this account for you and pays your property taxes, insurance costs, and other expenses when they are due.
For instance, if your homeowner insurance costs 1200 dollars per year and property taxes 2600 dollars per year, your lender is likely to take one-twelfth of the two costs and make it part of the monthly mortgage payment that goes to an escrow account. Thus, your monthly escrow payment would be approximately 292 dollars in addition to the principal and interest. That 12 x 292 dollars, or 3504 dollars, would be paid into your escrow account over the course of a year to cover your 3800 dollars total of insurance and taxes.
The concept behind escrow is to guarantee these large periodic homeownership payments are made on time. You do not have to rush to look for sometimes thousands of dollars when the local tax collector or the insurance company wants to be paid, you pay a small amount to the company on a monthly basis. This makes budgeting easier.
Escrow Account Analysis
Your lenders have the duty of reviewing your escrow account at least once every year to determine if the monthly contribution that you are making is enough or should be adjusted up or downwards. It is similar to fluctuations in your taxes, insurance, or other escrowed expenses you may have throughout the course of a year.
If there is a balance in your account, your monthly escrow could be reduced. If it is scarce, it may be necessary to adjust it upwards. Your lender will inform you if they notice surplus or shortage and whether your payment will be adjusted. You can also make a special request for an escrow analysis if you feel that there is a problem.
When an escrow shortage happens, one should not get behind on total monthly payments, however. The shortage just means that each month a larger amount has to be put aside to meet the actual expenditures. Your lender will almost always pass this increase over the course of one year, meaning the change will be small.
Escrow Advantages and Disadvantages
From the borrowers’ perspective, the component of escrow accounts has both advantages and disadvantages. On the bright side, escrow helps to simplify the budgeting of large periodic expenses, such as those related to a home. For example, you do not have to struggle to save lump sums for insurance, taxes, and many others on your own. To avoid getting into a situation where you will need to rush and settle these bills, it is wise to make payment of the escrow on a monthly basis. Once the funds are in escrow, your lender takes care of all the work for you.
However, the fact that insurance and taxes are also paid through the lender offers some security from this kind of fraud. This means you would not have to wait for fake bills to arrive that the criminals expect you to pay. Excessive bills are sorted out by the escrow mechanism.
On the negative side, when you allow your lender to handle this account, you lose some input on your money throughout the year. You have to rely on them to make the right payments at the right time. Of course, we can trust a number of lenders in most of the cases because the most companies have a good reputation.
The second potentially problematic aspect is associated with the required annual analyses of the existing and imposed conditions. If taxes or insurance increase significantly, your total monthly payment may increase if a serious shortage occurs. Situations where you are unable to earn enough to cater for this amount may prove detrimental to your loan. It is recommended to keep an eye on your escrow account information to prevent any unwelcome developments.
Am I Having an Escrow Account
If you are among the homeowners who pay their mortgage, you can determine if your lender is holding an escrow account for you by reviewing the loan documents or by reaching out to your lender. Many typical mortgages and almost all FHA insured mortgages require the establishment of escrow accounts. In general, Veterans Affairs VA loans do not require escrow but your lender may request one.
If you have an escrow account put in place, this will be indicated on your monthly mortgage statement, apart from the principal and interest. It helps you measure the percentage of escrow by comparing it to the total payment you have made. If there is no reference to escrow payment or your total credit is equivalent to the principle interest amount, you probably do not have an escrow account with your lender.
What If I Dont Want An Escrow Account
This means that some borrowers may be uncomfortable with the fact that their lender will be holding some of their money to cater for taxa and insurance. If you already have an escrow account but prefer to deal with these payments by yourself, you might ask your lender to close the escrow account. This normally entails providing receipts to show you are capable of making these payments on your own for several years without defaulting.
In general, lenders expect new borrowers to open escrow accounts initially when receiving a loan. But they can allow responsible owners to cancel escrow at some later date if bills are always paid on time. It alone is important to know that the lender can demand escrow again if there are gaps in payments in future. He or she should always bear in mind the convenience that escrow offers before looking for ways to close such an account.
Most borrowers are likely to benefit from escrow accounts linked to monthly home loan payments. When you know how these work, it helps you use escrow to facilitate homeownership and not just be a constraint that lenders impose. Handle your escrow well and it will handle key bills for you.
