My mortgage lender informed me that my escrow account, used to pay my homeowner’s insurance and property taxes, was underfunded recently. I could either send them a lump sum, or they could raise my monthly mortgage payment. The funny thing was that I received a check from my lender because my account was overfunded just last year. I was puzzled, as one of these two scenarios plays out every year. Is my lender acting on it’s own policies or are there laws governing the handling of escrow accounts? I decided to find out more about the inner workings of my escrow account.
Is An Escrow Account Required?
Lenders can require you to have an escrow account if your loan to value ratio is above 80%. To get rid of an existing escrow account, you generally have to refinance your mortgage so all the calculations can be done again. I personally don’t mind having an escrow account. It ensures that I have funds saved for my homeowner’s insurance and property taxes, and that they are paid on time.
Do Lenders Pay Interest On Escrow Account Balances?
The answer to this question varies by state as only a handful of states have passed laws that require interest payments on escrow account balances. The great state of Minnesota, where I reside, is one of those states.
What Causes an Increase or Decrease In Escrow Payments?
We normally think of expenses as gradually increasing over time. As your property taxes and homeowner’s insurance cost increase, so must your monthly escrow contribution. However, occasionally costs do go down. When the housing bubble burst in the early 2000’s, home devaluations also caused property taxes to decrease.
How Often Do Lenders Evaluate Escrow Accounts?
Lenders analyze escrow accounts once a year. The month a specific escrow account is analyzed is determined by the lender and the state your property resides in.
How Is An Escrow Evaluation Done?
You can easily do your own escrow evaluation. Create a chart that includes the months of the year in one column, and in another the yearly payments made with your escrow funds. Next, add columns that include your monthly contribution to your escrow account, which can be found on your monthly mortgage statement, and the resulting monthly balance. Don’t forget to put your starting escrow balance at the top of the balance column, and to deduct the payments from your account. Find the month with the lowest account balance. If that balance is below zero, then you have a deficit. Your lender will require you to give them either a lump sum in the amount of the deficit, or you can choose to split the deficit up into 12 equal payments added to your mortgage payment.
In the example table below, the mortgage holder has $1000 tax payments in both April and October, as well as a $500 homeowner’s insurance premium due in June. With a starting escrow balance of $800, and monthly payments of $150, they will have a negative balance after the tax payment in October. This fictitious homeowner would be required to either send the lender a check for $200, or their monthly mortgage payment could be increased by $16.67 per month.
Your lender may also require a cushion of up to 1/6th the total payments made from your escrow account over the next year. In that case, your deficit is the lowest balance that falls below that calculated cushion.
Do Lenders Have To Refund Overages?
If your escrow analysis shows that your lowest balance is greater than zero, or above the calculated cushion, it must refund any overage above $50 to you within 30 days. I had personally wondered about this, as typically the cost of insurance and property taxes increases. I may have liked to leave any overages in the account to be used at a later time. Unfortunately, federal law forbids this.
My mortgage is my largest monthly expense, and the cornerstone upon which the rest of my budget is built. I normally think of it as constant, however now that I understand more about how my escrow account works, I can plan for it potentially changing once a year.
Did you ever have questions about how your escrow account works? Do you have any additional questions or answers to add?
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What if the bank does this 2+years later?
The best remedy is to bank the excesses in plus years to pay for the future. You should also do what you can to pay it down so you aren’t paying PMI with your mortgage.