Mortgage Escrow Accounts Explained
What is mortgage escrow?
A mortgage escrow (or “impound”) account ensures that a borrower’s annual tax and insurance funds are included in the monthly budget and available when due. As part of your loan closing, you will receive a detailed review of escrow (in your loan estimate). And going forward, if you take a look at your mortgage statement, you can see it as a line item.
The reason your escrow money lives in a separate account is so a third party can pay property taxes and insurance premiums. More importantly, though, it helps borrowers by evenly spreading insurance and tax expenses over 12 payments instead of one lump sum.
Let’s consider an example. Say your annual property taxes are two payments of $1,000 each, and your annual insurance is $600. Direct payment once a year would require a $2,600 payment. With escrow, though, you can expect to make smaller, monthly payments of $217.
According to the Consumer Financial Protection Bureau (CFPB), you can be required to pay a part of the estimated annual total in advance, but no more than a maximum of one-sixth of the total (this gives you a two-month “cushion”). On top of the cushion, every month, your servicer can require you to pay one-twelfth of the total annual escrow payments the servicer reasonably anticipates paying out of the escrow account.
Is mortgage escrow necessary?
Not always. If your loan-to-value (LTV) is below 80% and you have a record of on-time payments, it may not be a requirement. Yet, it also depends on the loan program you select. Government loans like a VA loan or FHA loan often require escrow accounts because they are guaranteed. You’ll need to do your research on lenders and loan programs if you feel strongly about having a mortgage escrow.
Before waiving or canceling your escrow account, consider these issues.
Can my mortgage escrow amount increase?
Yes. There must always be enough money in your account to cover property taxes and insurance. If there is a tax reassessment or a change in insurance, you may see an increase in necessary payments, resulting in more dollars that need to be available in escrow.
How often is my escrow analyzed?
Annually. At the end of each year, you can expect your lender will review your escrow, property taxes, and insurance to see if your current account will cover the upcoming year’s payments. Know that lenders can collect an extra two months of escrow as protection in case your taxes or insurance are higher than expected. On the other hand, they are also required to pay you a refund at the end of the year if there is an overage -- meaning you have more than the minimum balance in your escrow account. This may happen if your taxes or insurance premiums were less than what was expected.