If you’ve just entered the real estate market for the first time, let’s be honest — it can be totally overwhelming. You’re hearing about contracts, contingencies, inspections, appraisals, assessments and more. I’m here to walk you through all of those pieces, and I want you to understand important terms about mortgages and the financial side, too. One such term to know and understand is “escrow.”
What Does Escrow Mean?
In the real estate world, an escrow is a deposit of funds held by a third party on behalf of two other parties that are in the process of completing a transaction. The funds are held by the escrow agent until receiving instructions for the fund or until predetermined contractual obligations have been fulfilled.
How Does Escrow Apply to Homeowners?
When you have a mortgage, you will likely also have an escrow account. An escrow account collects your payments for property taxes, homeowners insurance and sometimes additional items, in equal payments each month. These funds are used to pay bills on your behalf at the time they are due. Many of my clients want to know why they can’t pay those bills on their own, rather than having their money held in an escrow account. As long as your lender, or the investor who buys your loan, agrees, you certainly can!
This can be harder to arrange than it sounds, though. Investors want to make absolutely sure all bills are paid, and escrows are the surefire way to be sure that happens! See, if you fail to pay your property taxes, it will result in a lien against the house, which will supersede theirs. And if you don’t have current homeowners insurance and suffer a fire that results in a major loss, you won’t have coverage for the rebuilding of your home. Your home is their collateral. You can see how lenders and investors could be a little protective of the escrow account system.
Why Use an Escrow Account?
Taxes and homeowners insurance don’t come with small price tags. Most of my clients find it easiest to set aside the monthly amounts, making escrow accounts a convenience. Many folks will intend to set aside the same amount of money into a savings account of their own to later pay taxes and insurance premiums, but life can easily get in the way or you could be tempted to dip into these funds for emergencies. Before you know it, no matter how disciplined you are, payment dates can sneak up on you, and you’re not holding enough to cover the bills. While yes, you could be earning interest on your money elsewhere, the convenience of this type of required savings is worth it for most people.
How Much Will I Have to Put in Escrow Each Month?
To get a good estimate of your escrow amounts, first figure all items that will be paid through escrow — taxes, insurance premiums, association dues, etc. Add up all of these costs and divide the sum by 12. This is the monthly amount you’ll be setting aside in escrow to cover those annual costs. Lenders can require a bit of a cushion, but it cannot be more than one-sixth of the total amount paid into the account. (Basically two months’ worth of payments.) And remember, your escrow payment can change annually as taxes and premiums change. Your lender will notify you if you have a shortage or a surplus.
What Happens When You Have an Escrow Shortfall or Surplus?
At the end of each year, you’ll receive information about your escrow. If you face a shortfall in your escrow account, you’ll be presented with some options. Oftentimes, they tell you the shortage amount and offer a one-time payment option. Or you can make up the deficit by dividing the shortage amount by 12 and adding it to your monthly mortgage payment. Some lenders offer a combo of the two — pay some now and have less added each month. It just depends on your lender.
With surpluses, where the lender collects too much from you, it depends on the size of the overage. If it’s above a certain amount, they will send you a check. If it’s on the smaller side, it will be applied to the following year’s escrow payments.
For questions on escrow accounts, or anything related to the real estate market, please reach out! I’m happy to chat about your individual real estate needs and walk you through every step of the process. And if you’re looking to sell a house, too, I stage for free using your furniture when you list with me! Contact me today.