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Buying a home involves learning a lot of new terminology, and you’ll start hearing about escrow accounts once you get close to setting up a mortgage. Escrow accounts serve two important purposes. Your escrow account may hold your deposit to make sure it goes to the right party according to the conditions of the sale you and the seller agree to. Escrow accounts also hold money that’s earmarked for covering homeowners insurance and property taxes. Understanding how much money should be in your account helps you know when to plan to add to the balance.
Recognize the Benefits of Escrow Accounts for Homeowners
New homeowners sometimes question the reasoning behind having an escrow account. After all, it can sometimes be difficult to know funds are just sitting there out of your reach. Escrow accounts are designed to take the pressure off of you to come up with a large amount of money when property taxes or your homeowners insurance is due. On top of helping you make smaller payments throughout the year, your mortgage loan servicer will also make sure the bills are paid on time. Since missing even one day of your home insurance policy could jeopardize your finances, it’s worth having the peace of mind that comes with knowing your responsibility to pay is covered.
Understand How Lenders Calculate Escrow Requirements
Lenders perform an analysis of information about your new property that includes looking at past property tax records and insurance rates to estimate what your anticipated costs will be over the upcoming year. They’ll then divide the amount by 12 to break the yearly total down into monthly payments.
Know the Typical Amount Required to Be Held in Escrow
Escrow account amounts are regulated by federal and state laws, and anyone managing your account must comply with your loan agreement. The typical amount to keep in an escrow account is two months’ worth of your estimated payments. Having the extra cushion in your account protects you in the event that one or all of your financial obligations experience an increase in the amount you owe.
Expect the Amount to Change Over Time
Loan service providers should conduct an annual escrow analysis that examines factors such as your current balance and the payments that were made over the past 12 months. Since insurance rates and property taxes can change over the course of a year, this analysis could mean the balance you need to keep in escrow will also be different in future years.
Be Prepared to Handle a Shortage or Surplus
Estimating the costs for property taxes and other expenses isn’t a perfect science. This means homeowners sometimes discover there’s a shortage in the amount they’ve paid into escrow. In a good year, you might have a surplus. With shortages, you’ll need to submit funds to make up the amount. Surpluses are usually paid out as an escrow surplus check, which you can use any way you like.
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