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. I wanted to 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:
- They are not over-collecting each month.
- Collecting enough each month to pay the annual homeowners insurance and property tax payment.
- They they are not retaining excess of what is required.
There should be enough in escrow to pay the tax and insurance payment and having 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 have 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 simply 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?
Generally speaking, with most lenders, yes you will have to maintain an escrow account. There are exceptions that are made on a case by case basis but have to be approved by the lender as part of the loan approval. Typically, if your loan is a low Loan-to-Value (LTV), and the borrowers have decent credit, an escrow waiver is granted.
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.