When you buy a home with less than 20% down, your mortgage company will usually require an escrow account for your property taxes and homeowner’s insurance. Your home is collateral for the mortgage debt, and your lender wants to avoid the risks associated with non-payment of these items. They collect the money from you in monthly installments, then make the annual or semi-annual payments directly to these parties on your behalf.
When an escrow account is required, your total monthly mortgage payment will include two components: the principal and interest portion (P&I) and the escrow for taxes and homeowner’s insurance (T&I). If you have a fixed-rate mortgage, the P&I component remains the same within your payment. But the escrow component may be adjusted to accommodate changes in your tax bill or homeowner’s insurance premiums.
If you live within a homeowner’s association, HOA dues may be escrowed within your monthly mortgage payment. You may also have a mortgage insurance premium (MIP for FHA loans or PMI for conventional loans) in your payment as well. For the sake of simplicity, our examples will focus on escrow for the payment of property taxes and homeowner’s insurance premiums.
Say you have annual property taxes of $7,500, and an annual insurance premium of $750. These two items would total $8,250 per year. Your monthly escrow would be based on $4,200 divided by 12 months = $687.50 per month. This $687.50 would be added to your principal and interest payment, to create your total monthly mortgage payment.
One catch: Federal law allows mortgage servicing companies to hold up to 2 months of escrow in reserve, as a safety net against increases in your escrowed bills. Using the above example, your mortgage company could require your escrow account to keep a “minimum balance” of $1,375 equaling 2 months of your escrow deposit. In order to establish and maintain this reserve, the escrow portion of your payment could be occasionally increased.
Escrow accounts are balanced each year to compare the outgoing disbursements against the funds being deposited. This may be referred to as an escrow analysis. It works similar to balancing a checking account, and rarely do things line up perfectly. Tax and insurance bills can change year to year, and your escrow account may run a shortage, or a surplus, as a result.
In the event of a surplus, your lender will send you a check for the amount of over-payment. Don’t celebrate with this refund; the same escrow account may show a shortage the following year. This is especially true for new construction, when the property hasn’t been fully assessed yet, resulting in an initial tax bill that is abnormally low. Your best bet is to save any escrow refund, so you can be prepared when the scales tip the opposite direction.
In the case of an escrow shortage, your lender will collect the difference from you. First, your monthly escrow payment will be increased to match the actual payout from escrow. If your monthly escrow was estimated on disbursements of $8,250 a year, but they actually amounted to $9,000 a year, your new monthly escrow requirement will be $750 a month. ($9,000/12 = $750.)
But wait, there’s more! Your lender also needs to recover the $750 difference, which wasn’t collected from you in advance. (This situation happens when a tax or insurance bill comes in higher than estimated.)
To make up for the shortage, your mortgage company will give you two options: 1) pay the shortage in a lump sum of $750, or 2) prorate this over the next 12 months, adding it to your monthly payments. If you choose the latter, you’ll have an extra $62.50 tacked on the new $750 escrow payment, for a total of $812.50.
If you have an escrow reserve, or two-month cushion required, your lender will tack on a little extra to bring this reserve balance in line with your new escrow calculations.
Assuming you have no further increases in tax or insurance bills the following year, the shortage proration in the escrow payment would drop off. What to watch out for, are year-over-year increases in tax bills, insurance premiums, or other obligations managed in your escrow account. If something is always “going up” in cost, your escrow account could be in a perpetual game of catch-up.
The good news: having an escrow account provides built-in monthly savings towards your property taxes, homeowner’s insurance and other obligations. If a tax bill comes in higher than expected, your mortgage company still pays it on time, and collects the difference from you later. There is no interest or penalty on an escrow shortage – but there are interest and penalties on past-due tax bills, along with other serious consequences.
Columbus home buyers should keep property tax bills, insurance premiums and other ownership expenses in mind when considering their home buying budget! These expenses can increase as time goes on. If you do not have an escrow account requirement, you’ll need to plan ahead and save diligently for these items on your own.
As your Exclusive Buyer’s Broker, we serve your best interests at all times! Unlike real estate agents and brokerages who represent sellers, as an Exclusive Buyer’s Broker, we only represent you, the buyer, getting you the best price and terms with no conflict of interest at all times.
Understanding this distinction could literally save you thousands of dollars not only on the purchase price and terms, but also on seller concessions and home inspection issues, whether you are a first-time homebuyer or an experienced homeowner!
Contact us with your home buying questions! Remember, we are with you every step of the way…all the way home!
Andrew Show
Exclusive Buyer’s Broker, CEBA-M, MCNE, CSP, PSA, e-PRO, CREM, ABRM, AHWD
Buyer’s Resource Realty Services, www.buyershome.com
Serving Metro Columbus, Ohio with Exclusive Buyer’s Agents
7100 North High Street, Suite 204, Worthington, Ohio 43085
614-888-4110 | 888-888-4110 Toll Free | 614-839-4110 Fax
