Two things that influence a mortgage escrow account the most:
- Property tax on the home-Most lenders requires this in escrow because if the taxes are not paid, your municipality could place a lien on the property that would have a higher priority than the mortgage lender’s lien.
- Homeowner’s insurance policy – All lenders require home insurance because of the investment they are making in your home.
The day you close on your new home, your lender will usually require you to open an escrow account to cover property taxes and homeowner’s insurance. You make the initial escrow deposit, followed by payments to the account every month. The monthly escrow payment is calculated by taking the total of all projected tax and insurance payments for the coming year, and dividing that number by 12.
When making your mortgage payment, you may have the option to pay extra into the escrow account, which is a very smart choice since property taxes or insurance premiums may rise. This helps to avoid the increase to be paid all at once. The benefit of this to borrowers is that this plan helps to stretch insurance and tax expenses evenly over 12 payments. For example, assume your yearly property taxes are two payments of $1,000 each, and your insurance is $400 annually. If you paid these directly, it would mean three large payments a year; your escrow costs, however, would be a manageable $200 a month. When the tax or insurance payment is due, the lender pays the bill using the funds accumulated in the mortgage escrow account.
If you have a Conventional Loan and you do not have PMI (Private Mortgage Insurance), you have the option to close your escrow account and make your own tax and insurance payments. If you have a VA or FHA loan, the lender may be required to continue to keep an escrow account for the life of the loan making this a provision in order to receive the funds for your government-insured loan.
This strategy protects the lender by making sure you pay your taxes and insurance on time. If you default on your property tax, for example, your municipality can put a lien on the house, which would make it difficult to sell. If your house burns down and you have neglected to pay your homeowner’s insurance, the lender is going to be without collateral.
Here is a little mortgage lingo for you. Since mortgage escrow payments are applied to taxes and insurance, you may hear it addressed as T & I, while the mortgage payment consisting of principal and interest is called P & I. They both equal PITI for Principal, Interest, Tax, and Insurance. Occasionally you will hear these terms from your lender.
By RESPA (Real Estate Settlement Procedures Act) guidelines, escrow payments will be evaluated at least once every 12 months to account for any increases in property taxes or insurance. This is known as Escrow Analysis.
Any overpayment of $50 or more will be refunded to the borrower or your lender will send you a bill at the end of the year to make up for any shortage in your escrow account based on the tax and insurance bills.