An escrow account is a non-interest-bearing account that sets aside roughly one-twelfth of your annual property taxes and homeowners insurance each month with your regularly scheduled payments. An escrow account is not managed by the homeowner, but rather the loan servicer to ensure that there is enough money to pay taxes and insurance while maintaining an appropriate "cushion" to minimize shortages from unexpected increases when those bills come due.
When the home mortgage loan is obtained, the homeowner is often required to deposit several months' worth of homeowners insurance and property taxes into the escrow account. The initial deposit is paid at the loan closing. Then, each month, the mortgage payment includes the escrow account payment for taxes and insurance.
Lenders will require an escrow account anytime the down payment is less than 20% on a house. If there is more than 20% equity in the house, you may choose to not have an escrow account. Loans without an escrow may have a higher interest rate or closing costs because this creates more risk for the lender. With an escrow account, the lender is responsible for and knows that the taxes and insurance will be paid. Without an escrow account, the lender is at risk if the insurance should lapse or the taxes aren't paid.
If you have more than 20% equity, you may opt to forgo an escrow account and, therefore, be responsible for paying taxes and insurance yourself, or select to have an escrow account and let your mortgage servicer handle that for you.
An escrow shortage is when there is a negative balance in the escrow account and not enough money to pay your bills plus maintain the required cushion. The most common reason for an escrow shortage is an increase in property taxes, which results in an increase to the escrow payments. Other possible reasons for escrow shortages include a rise in homeowners insurance and a miscalculation of the escrow payment when the home loan was originally started.
Escrow accounts are analyzed annually for changes in tax and insurance values. If it is determined that there is an escrow shortage, the homeowner will receive notice of that in the mail. Homeowners can take proactive measures to avoid escrow shortages by being mindful of information received from the city regarding taxes and homeowners insurance. The local tax offices will often mail notices about changes, which can help the homeowner plan for increased escrow payments. It is rare to have an overage in an escrow account, but occasionally it does occur, especially with new construction. In the event a servicer refunds escrow money and lowers a payment, that is a red flag - reach out to your loan officer to have further analysis as to whether you should keep those monies or return them to your escrow account.
I can answer your questions about escrow accounts and any questions you have about the mortgage process. Call me today to set up an appointment.