Real estate is rife with complicated financial terms that may end up sounding like another language to the average person. One term that you are likely to hear a lot while entering the housing market is “escrow.” While that term has multiple meanings, depending on the context, the escrow associated with your mortgage refers to money or documents held in trust by an impartial third party. Many real estate deals utilize two types of escrow accounts, also known as reserve or impound accounts. The first is a temporary account that holds a good faith deposit in reserve until the closing day. The second type is a permanent account set up to hold funds for expenses like property tax and homeowner’s insurance payments.
What is Escrow?
Designed to protect against fraud, nonpayment or some other form of financial malfeasance, an escrow account provides some peace of mind to all parties involved in a transaction. In essence, Escrow refers to a third-party service that is part of every home purchase. When a buyer and seller initially arrive at a purchase agreement, they select a neutral third party to act as the escrow agent. The escrow agent collects a deposit from the buyer that is equal to a small percentage of the sale price. This deposit is known as “earnest money”. In exchange, the seller takes the property listing off the market. Until the final exchange is completed, both the seller’s property and the buyer’s deposit are said to be in escrow.
What Is an Escrow Balance?
If your mortgage is escrowed, then your monthly payment is split into three parts. Two parts go toward principal and interest, according to your loan’s amortization schedule. Initially, most of your monthly payment covers interest. Over time, more will go toward your principal.
The third part of your payment goes toward your escrow balance. In many mortgages, funds are held in escrow to pay property taxes and homeowners insurance. When your taxes or insurance is due, the company servicing the loan will take the money out of your escrow balance to pay those bills.
As most of these payments are often made on an annual or semi-annual basis, your lender will bundle all of these payments together in an escrow account to be paid alongside your monthly mortgage payment.
When you access your monthly mortgage statement, you will find your mortgage payments separated into three categories:
- Interest Payments
- Principal Payments
- Escrow Payments
Unlike interest and principal, escrow payments do not count toward the actual debt of your loan. Rather, escrow counts toward services and fees, such as insurance premiums and property taxes that must be paid under law.
Your lender handles payment of your escrow services because it would be difficult for most people to come up with the lump sum of money required each year to pay for property taxes, semi-annual insurance premiums, etc.
What Does My Escrow Balance Pay For?
Your escrow balance with your mortgage lender pays your homeowners insurance, hazard insurance, mortgage insurance (if applicable), and taxes. The due date of these bills is completely managed by your lender and your escrow account works as a holding account of sorts to ensure that these bills are paid to the appropriate parties and in a timely manner.
During the mortgage process, it may be possible to opt-out of impounds. When lenders use an escrow account balance to hold funds for tax and insurance payments, they will know that these bills will be paid automatically and on time, thus protecting their investment in your debt.
Minimum Balance Requirements
The federal Truth in Lending Act specifies when and for how long a lender must establish a permanent escrow account, and Section 10 of the Real Estate Settlement Procedures Act covers escrow balance requirements.
Balance discrepancies often occur because property tax and insurance payments are based on estimates for the coming year. To prevent shortages that may result from inaccurate estimates, RESPA laws allow – but do not require – escrow account administrators to establish a minimum balance rule. Unless state laws differ, a cushion of one-sixth of the total annual bills for all escrow payments is the maximum allowed. In keeping with standards established by the U.S. Department of Housing and Urban Development, this usually equates to about two months of escrow payments.
Why Does My Escrow Balance Change?
Escrow balances can change due to the fluctuation with property taxes and insurance premiums. Any change to your escrow balance will result in a change in your monthly mortgage payment.
It is important to track the annual changes in the amounts due under your homeowner’s insurance policy and to your local jurisdiction for real estate property taxes. Your lender will conduct yearly reviews and may adjust the escrow portion of your mortgage payment due each month to cover any such changes. If you are not aware of these changes, you may be surprised by a larger monthly mortgage payment when your lender re-evaluates your escrow account.
How Can I Monitor My Escrow Account Balance?
During the first year of a mortgage, over-payments in a mortgage escrow account will be difficult to assess. The ideal time to review your escrow balance is after the first of the year when your lender will be able to show you your current balance and all payments that have been made for the previous year. While lenders are required to keep a certain level of funds in reserve in your escrow account, there’s no need for excess funds to be held. Lenders automatically send refund checks to homeowners each year when there is an overage. You may also receive a notice asking if you’d prefer a refund check or to apply the overage in your escrow balance to your mortgage principal.
Be sure to ask your real estate agent and lender any questions you may have about managing an impounds account for years to come. And do not forget to review this process again, especially with impound accounts, should you choose to refinance down the line.
When Do You Get Escrow Refund Checks?
There may be some instances when you have built up a surplus of funds in your escrow account. The overages could total more than what is needed or allowed to be held in the account. If you find yourself in either of those scenarios, you might receive an escrow refund check.
You will likely receive an escrow refund check once your lender has done their required annual escrow account analysis. But, if you are eligible, you can request a refund at any time of year. To be eligible for a refund, you must be current on your payments; otherwise, your mortgage servicer may be allowed to keep the surplus and use it for future bills.
Let’s take a look at some refund scenarios:
- Overpayment: If you opened an escrow account for your earnest money deposit but you put in more than you needed to, you should get your unused escrow money back when the account is closed.
- Lower Taxes: If your property tax was lowered and you deposited more into your escrow account than what was necessary to cover it, you may get an escrow refund.
- Homeowner’s Insurance Bill Change: This is similar to the property tax scenario. If your insurance premium decreases, there may be excess funds in your escrow account that may be refunded to you.
- Mortgage Pay Off: If you have an escrow account balance after paying off your mortgage, it should be refunded to you.
If you think you are eligible for an escrow refund, check with your mortgage servicer to see what their escrow refund policy is and if you meet their refund requirements.
What Happens at Citrus Heritage Escrow?
Your escrow officer follows instructions on your contract, coordinates deadlines, and gathers all necessary paperwork. For example, written requests for payoff information (called “demands”) are sent to the Seller’s mortgage company and any other lien holders.
During the escrow period, the title company coordinates with Citrus Heritage Escrow and begins researching and examining all historical records pertaining to the subject property. Barring any unusual circumstances, a commitment for title insurance is issued, indicating a clear title or listing any items which must be cleared prior to closing. The commitment is sent to you for review.
When choosing an escrow company there can be many important factors to evaluate. Fees, location, staff and even recommendations from friends and colleagues are all things to consider. With Citrus Heritage Escrow by your side, you can rest assured that when you receive your settlement check, you’ve gained the maximum benefit from your home sale or purchase.
Call us today with any questions or concerns. Our professional Escrow Agents will help you through this exciting yet confusing process. (951) 335-7200