Escrow likely sits toward the top of your list of the last things you want to talk to somebody about at a party. However, it really is something you need to understand, including how it works to effectively, and wisely manage your mortgage and finances. To keep it simple, Candice Rachels is Vice President, Product Development Manager, is sharing all you need to know about escrow below.
Candice leads the Product Development department in developing an enhanced portfolio of home loan products for PrimeLending. Additionally, she is responsible for overseeing PrimeLending’s mortgage product guidelines and analyzing the suite of product offerings.
What is Escrow?
Escrow is money collected as part of your monthly mortgage payments that’s used to pay your property taxes and insurance. Who collects it? The company to whom you pay your monthly mortgage payments, which is your mortgage servicer. But who is that?
Your mortgage servicer is the company that manages and conducts all the activities connected to your loan. For instance, they’re the ones you talk to if you have questions or concerns about your loan. They keep track of the principle and interest you pay, collect and process your payments, and manage your escrow account. It’s important to know that your loan servicer is not always the company that gave you your loan. Servicing “rights” are often sold to another company that specializes in conducting the day-to-day activities connected to a mortgage loan.
How Does an Escrow Account Work?
An escrow account is established when you close or finalize your loan. Your monthly mortgage payments are divided into three parts: principal, interest, and escrow which is put into a dedicated account to cover your home insurance and property taxes. How much escrow will be collected for the year is estimated based on current tax rates and the home’s yearly insurance premium. That amount is divided by 12 and spread across your monthly payments. Because it’s common for tax rates and insurance premiums to fluctuate, lenders are allowed by law to keep enough money in the account to cover payments for up to two months to cover future increases. This cushion is usually included in the loan’s closing costs.
Is an Escrow Account Required?
It depends. Lenders often require that an escrow account is set up for loans with less than a 20% down payment, and for certain government-backed mortgages like VA and FHA loans. To avoid having an escrow account part of your mortgage, lenders generally require a down payment of at least 20% of the loan.
What are the Pros and Cons of an Escrow Account?
One of the biggest advantages is your mortgage servicer has the responsibility to make your property tax and insurance payments. They’re using your money, but you don’t have to worry about making or missing monthly payments or figuring out how to pay a giant tax bill at the end of each year. It can also help with budgeting because taxes and insurance premiums do fluctuate. On the other hand, you are paying money up front to the lender that you could otherwise be investing or put into savings. If your loan doesn’t require escrow, and if you’re disciplined and good at planning and saving, it could be a good idea to manage these payments on your own and not set up an escrow account.
Why Does Escrow Sometimes Change?
As we know, tax rates and insurance premiums go up and down. When these changes don’t match what’s being collected a shortage or surplus can happen. If your account ends up with more money than required, that’s surplus. If the account does not have enough money to cover taxes and insurance, that’s a shortage. If your escrow account does come up short, don’t worry. Your servicer will make sure the payments are made. You can then either cover that difference, or shortage, with a one-time payment, or have it spread across future monthly payments. If your account ends up with a surplus, that money will either stay in your account to cover future payments, or you might receive that amount returned to you, depending on your servicer or the terms of your loan.
Can You Challenge How Much You’re Paying in Escrow Payments?
Yes, you can. But it’s important to know that your lender or servicer does not determine how much you pay for property taxes and insurance. Tax rates are set by your local tax authorities. Insurance premiums are set by your insurance provider. If you think what you’re paying is too high or doesn’t seem right, you should first contact them directly.
Can You Close an Escrow Account and Start Making Payments on Your Own?
It’s possible, but many lenders or servicers will have different requirements attached to closing an escrow account. Generally, you’ll need to have at least 20% equity in your home. Your lender or servicer may also require an escrow cancellation fee, and to receive your request in writing. If you have a government-backed mortgage like a VA or FHA loan that requires an escrow account, you likely won’t be able to close the account to take the responsibility of paying your property taxes and insurance. Contact your servicer to ask what their policy is.
Once you understand how it all works, it really takes care of itself. Either let your mortgage servicer have the responsibility to manage and make these payments on your behalf, giving you less to worry about. Or just make sure property tax and insurance payments are part of your monthly and yearly budget planning. If you have any questions about escrow or mortgages in general, a PrimeLending Home Loan expert can help.