What is Escrow?
One of the biggest concerns that I deal with from borrowers that are either refinancing or purchasing their home is money being collected for their escrow account. Let’s take a minute to explain how your escrow account works.
What is an escrow account?
Simply put, an escrow account is a separate account that is attached to your mortgage that holds funds that are paid out for property tax and homeowners insurance. There are regulations in place that require the mortgagee (lender) and/or servicer of the loan to reconcile the account each year to make sure:
1. They are not over-collecting each month.
2. They are collecting enough monthly to pay the homeowners insurance and property taxes.
3. They they are not retaining excess of what is required.
There should be enough in escrow to pay the tax and insurance payment and have a buffer of no more than two (2) months in the account. Any excess in the account after paying the tax and insurance, and leaving a two (2) month buffer in the account is refunded each year. Conversely, if not enough was collected, the escrow payment is adjusted to ensure that the next year will have ample funds to satisfy the obligations. The important thing to realize is that the escrow account is YOUR money. Instead of getting a bill each year from the county in which you reside and the insurance company, the bill is sent to the lender who in turn pays it on your behalf. Effectively, you would be looking at a bill for thousands of dollars. If you did not plan accordingly for the tax and insurance, or know when it becomes due, you would be subject to a potential hardship. The escrow account is designed to eliminate that risk by collecting 1/12 each month.
I am refinancing my home and already ahve an escrow account.
That is true. The thing to keep in mind when you are refinancing your home is that the escrow account is your money. You have a couple of options on how you want the current lender to distribute the funds from your escrow account:
- The current lender can keep the funds that are currently in escrow and apply it to unpaid principle. This would lower the payoff of the home.
- The current lender can refund the escrow balance to you. This would be sent somewhere around three (3) weeks after closing on the refinance and is generally sent as a paper check via the mail.
Because the escrow is tied to a particular loan, funds cannot be transferred when you refinance. Instead, as the new loan is structured and funded, an escrow account is created with ample funds to satisfy tax and insurance obligations.
Do I have to maintain an escrow account?
This depends on the lender’s policies. We do have lenders that will waive escrow for qualifying borrowers. Keep in mind that by waiving escrow (paying your homeownsers insurance and taxes outside of your escrow account), you will be responsible for paying your insurance and taxes on your own. Often times, borrowers prefer to pay these items from their escrow account so that they can budget it and pay monthly instead of annually. We can run the calculations so that you know around how much the property tax will be each year to assist you in making a decision. Also, you do have the option with some lenders to waive only a portion of the escrow. So, if you wanted to pay your homeowners insurance yourself, you could still collect the taxes into your escrow account.
How do they know how much is collected for my escrow account?
Each county publishes millage rates, which are the approved tax rate for the area that your house resides. Simple calculation (loan amount * millage rate) gives an amount that would be due for tax minus any homestead exceptions that may apply. If the loan is a refinance, the lender will also look at the tax cert (the amount that you have paid) for the last two (2) years. The insurance is collected either in the form of a quote for a purchase, or a declaration page for refinance. If you add those two (2) values together and divide by twelve (12), you will have the escrow payment.
Why does homeowners insurance show up twice on my Loan Estimate (LE)?
This typically happens on purchase transactions. You will notice in Section F of the LE, it is for prepaids. This amount does not actually go into your escrow account. Instead, at closing, the funds are distributed to the insurance company to initiate the policy. Your LE should show the full amount of the quote that you provided. Section G of the LE is the actual escrow that will be collected at closing. If a full year is collected in section F, you should still see two (2) or three (3) months collected in section G. This is an escrow reserve.