What is escrow?
Escrow is an account held by your lender or servicer, separate from your mortgage account, that collects money from you every month, in equal amounts, to pay for your property taxes, homeowners insurance, and in rare cases other items.
How is it calculated?
The amount you’ll pay each month is an equal portion of the total amount of money you’ll owe for the year in property taxes and homeowners insurance. So if your annual property taxes are $2,000 and your insurance is $800, your escrow payment will be $233.33 every month – $2,800 divided by 12.
It’s important to note that your property taxes can fluctuate from year-to-year, which means your escrow may be higher one year versus another. Lenders might also take slightly more out, no more than one-sixth of the total amount paid, to act as “cushion.”
Do you have to have it?
Some lenders will require you to have an escrow while others may waive it for a fee. The goal of the escrow account is to ensure the property taxes and homeowners insurance are paid on time.
Many people opt for having it because unless you are an extremely disciplined saver and will be sure to set money aside each month, you might end up not being able to afford the payment come the end of the year when it’s due.
Who pays it?
A benefit, besides you not having to pay a giant lump sum at the end of the year, is the lender or servicer will be in charge of making those payments for you when it’s time. If they pay it late, they’re responsible for any late fees.
Keep in mind you should still monitor your account to make sure your lender is taking out the correct amount and paying on time.
What if you have too much or too little in your account?
If you have too much money in your escrow account your lender will either refund you the money or apply it to next year’s escrow. It’ll depend on the amount of surplus you have.
If you have a shortage of funds, the lender will either ask you to pay the difference in full immediately, or via 12 equal payments over the following year.
Talk to your lender
The best way to understand the terms of your escrow, and whether it’s the right choice for you or not, is to talk to your lender. Ask questions, that’s the only way you’ll learn about your new investment.