Which bills will be paid from an escrow account is a common question home buyers ask. It is a reasonable question, and an important one to be asking during a real estate transaction. When you close on a mortgage, your lender may set up a mortgage escrow account where part of your monthly loan payment is deposited to cover some of the costs associated with home ownership. The costs may include but are not limited to real estate taxes, insurance premiums and private mortgage insurance. This practice ensures that payments are made on time to third parties, such as county taxing authorities and insurance companies.
What is Escrow?
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.
How Does An Escrow Account Work?
An escrow account is set up to collect your payments for such things as taxes and insurances, in equal amounts over a 12-month period, to be paid on your behalf when those bills come due. The question most people have is why they cannot pay these bills on their own? And the answer is you can — if your lender agrees.
But while the choice is entirely up to the lender, keep in mind that these investors want to make absolutely sure those bills are paid so they almost always require escrow. After all, if your property taxes are not paid on-time every time, it will result in a lien against the house. And if your insurance is not up-to-date and you endure a major loss, there will be no protection to cover the cost of rebuilding your home, which serves as the underlying collateral for your loan.
Which Bills Will Be Paid From an Escrow Account?
The money from your escrow account will pay the following:
- Property Taxes
- Homeowners Insurance
- Mortgage Insurance (if required)
- Flood Insurance (if required)
Please note that the following items will need to be paid separately:
- Interim tax bills, special or added tax assessments (or any other fees that are not included in your property tax bill)
- Homeowners Association Fees (if applicable)
- Supplemental Tax Bills (if applicable)
- Premiums for Non-required Insurance Policies (such as separate personal property insurance)
Property Tax Payments
Your lender must work directly with the county tax collector to obtain the information on your property taxes. The county sends the tax bill to the lender for review. The lender then makes a payment to the county using the money from your escrow account. You should also receive a copy of your tax bill for your records; however, you don’t need to pay your tax collector directly.
Homeowner’s Insurance Payments
Homeowner’s insurance premium is often paid from a lender’s escrow account. Part of the monthly payment made to the lender includes money to be deposited into the account. Homeowner’s insurance is a requirement for obtaining a loan.
Flood Insurance
The hazard insurance section of standard homeowner’s insurance policies does not cover flooding from external natural causes, like heavy rainstorms, or man-made ones, like a dam break. Only specifically named flood insurance, a separate insurance policy, can protect against that sort of destruction or damage. Flood insurance is usually optional for mortgaged homeowners in what are normally considered low-risk flood areas.
Be Prepared For Escrow Payment Variations
Even if you have a long-term fixed-rate loan, your mortgage payment can vary. The principal and interest portion of your payment is fixed, but tax assessments may change and insurance premiums may fluctuate. This makes your entire payment vary.
To be able to cover possible shortages in payments, lenders require an extra 2 months’ worth of payments be kept in the account as a reserve cushion. Tax assessments and premium adjustments can happen any time during a 12-month period, and lenders will have to cover those shortages either using your escrow account or their own money. If they use their own money, they will recover the shortage by requiring an increase in the amount you deposit monthly into escrow.
Also, when building a new home, understand that your escrow payments may spike once construction has been completed because when lenders calculate escrow, the amount is based on the last disbursement. The last disbursement may only reflect the taxes on the land (if there was no previous house on that land). When construction is complete, the land is now worth more because of the existence of the home; therefore, escrow will be higher.
What If You Have an Escrow Shortfall or Surplus?
If there is a shortfall in your escrow in any given year, your lender is likely to offer some options to make up the difference. For example, you can pay the shortfall in full now or via 12 equal payments over the following year, so the deficit is made up by the next anniversary of your loan. Sometimes, you may even be offered a combination of the above — pay some now and the rest over the next 12 months.
If there is a surplus in your account — the lender collected too much over the previous year — one of two things will happen, depending on the size of the overage. Above a certain amount, the lender will cut you a check. For smaller surpluses, the lender will apply it to next year’s escrow payments. If you are given a choice, realize that what lenders giveth in one year is likely to be taken away next year in the form of a tax increase or higher insurance premiums. Unless you absolutely, positively need the money, it is almost always better to let it ride.
What Happens at Citrus Heritage Escrow?
Buying a home should be an exciting time in your life. While it is easy to get overwhelmed by all the line items on your loan, a qualified home lender will be there to guide you through every step of the process.
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.
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