21 Escrow Loan FAQs: Addressing Common Borrower Inquiries
Bob Schulte
Mar 27, 2024
11 mins read
The term ‘escrow loan’ is familiar to many borrowers, but few understand it completely. This lack of understanding can complicate the loan journey. Both lenders and borrowers need a clear understanding of escrow before embarking on the escrow mortgage journey. Escrow loans are fundamental to many financial transactions, providing a safety net for both parties.
In fact, escrow services are so crucial that the global escrow market size is projected to reach $12.86 billion by 2025, according to a report by Grand View Research. This highlights the significant role escrow plays in facilitating secure transactions.
In this blog, we’ll address some of the most common questions about escrow loans. Whether you’re a first-time homebuyer or financing a new project, these FAQs will demystify the escrow loan process, empowering you to make informed decisions. Let’s begin!
An escrow loan account or a mortgage escrow account is an exclusive holding account that holds funds for the borrower’s mortgage. It acts as a neutral third-party account, managed by your mortgage lender, that holds funds for the payment of property taxes, homeowners insurance, and other types of expenses.
The purpose of an escrow account is to ensure that the property-related expenses are paid on time, reducing the risk to the lender. By requiring borrowers to maintain an escrow account, lenders can ensure that property taxes and insurance premiums are paid promptly, which helps protect their investment in the property.
An escrow loan works by establishing a separate holding account for the borrower’s monthly payments towards taxes and insurance. The lender takes into account your mortgage, property value, etc. to calculate your annual tax and insurance payments.
This amount is divided into 12 monthly payments and added to your monthly mortgage statement. Out of the total monthly payment, the lender ensures that the portion going towards the taxes and insurance is securely held in escrow and is paid on time.
This way, you do not have to keep track of multiple payments and only make one payment for all your mortgage and property related obligations.
Escrow accounts are necessary for mortgage loans primarily to mitigate risks for lenders by ensuring timely payment of property taxes and homeowners insurance, safeguarding their investment in the property. They also provide convenience for borrowers by allowing them to make a single monthly payment covering mortgage principal, interest, taxes, and insurance.
| Escrow Account Components: Property Taxes: The portion of your escrow payment that goes towards property taxes is based on the estimated annual property tax bill divided by 12. Homeowners Insurance: Similarly, the portion for homeowners insurance is based on the annual premium divided by 12. Lenders require homeowners insurance to protect their investment in case of damage to the property. Other Expenses: Depending on your loan and location, your escrow account may also cover other expenses such as mortgage insurance. It is required for loans with a down payment of less than 20% of the home’s value, or homeowners association fees. |
Your lender calculates escrow by factoring in the annual estimated expenses of insurance and property tax (and HOA if applicable) and then dividing the total by 12 to determine the monthly amount.
Example:
Borrower obligations other than mortgage (annually):
Property tax: $1500
Insurance: $1000
Other insurance (expenses): $1300
Total: $3700 (annually)
Escrow monthly payment: 3800 ÷ 12 = $316.667
This amount is added to your monthly mortgage expense so you only have to make one combined payment. Out of this, $316.667 goes towards taxes and insurance and the rest goes towards your mortgage principal and interest.
Your escrow loan statement typically includes the details of your monthly escrow payments along with the other required information such as starting date, account balance, account number, etc. The statement includes:
The minimum amount required to be maintained in your escrow account varies from lender to lender. However, typically, borrowers are required to maintain a minimum balance of up to two months of their escrow payments. This ensures that there is enough balance to cover any potential payment increase in the future.
If you have a surplus in your escrow mortgage account at the end of the year, your lender will refund that money to you. You can also ask the lender for the refund by yourself. In some cases, borrowers also ask their lender to adjust the surplus amount in their future escrow payments.
Most borrowers are required to pay escrow for their mortgage for the life of the mortgage, especially for FHA loans and other government-backed loans like USDA. For other mortgage types, the lender may choose to waive the escrow when the borrower reaches a certain point in the loan journey, (for example, 20% equity is achieved by the borrower for the home). Ensure you have discussed all the terms before beginning the escrow process.
Escrow acts as a neutral third-party holding account which is managed by the lender. The amount deposited by the borrower is paid towards mortgage, taxes and insurance, ensuring the payments are made on time. It also reduces the risk of default by the borrower, thus protecting the lender’s investment. Additionally, it helps borrowers to make only one monthly payment and ensures that their obligations are fulfilled on time, thus protecting their credit worthiness.
Escrow can be a valuable tool for borrowers to streamline their mortgage payments and ensure peace of mind. By automatically collecting funds for property taxes and homeowners insurance alongside your regular mortgage payment, escrow eliminates the worry of missed payments, late fees, and potential policy cancellations.
For lenders, escrow ensures reduced risk and administrative efficiency. Escrow helps guarantee that essential property tax and insurance payments are made on time, minimizing the chances of a borrower defaulting on the entire loan due to delinquency on these crucial expenses. Timely tax payments ensure the lender maintains a legal claim on the property, while homeowners insurance safeguards the property’s value, protecting the lender’s financial investment.
Escrow loan account often comes with disadvantages such as less control over your property related expenses, no interest on funds being held in the third party account, inaccurate estimates which may result in surplus or shortage of funds, and frequent fluctuations in the amount due to changes in tax and premiums.
An escrow overage happens when there’s more money in your escrow account than what’s needed to cover your upcoming property taxes and homeowners insurance bills.
A shortage in your escrow account arises when there isn’t enough money in it to cover your upcoming property taxes or homeowners insurance bills. This can happen if there’s an increase in property taxes or insurance premium or if there was an inaccurate estimate. You can cover for this shortage either by paying a lump sum amount or coming up with a payment plan with your lender to distribute the shortage amount over a period of a few months.
Lenders typically perform escrow analysis annually to ensure that the monthly payments of the borrowers are sufficient to cover upcoming property taxes and insurance. This amount is increased or decreased based on the current rate of taxes and insurance. It is done by your lender by gathering information about upcoming expenses, calculating the monthly payments, comparing it with your current monthly payments, notifying you and then adjusting your stipulated payment based on the new amount.
Your escrow payment can definitely change after an analysis based on the upcoming year’s tax, insurance and other expenses. If the property tax percentage goes down, then your escrow payment will reduce. On the other hand, if the tax and insurance payments go up, then your escrow payments will increase. Under any case, your lender will notify you in detail whether your monthly escrow payment will change or remain the same for the coming year.
You can change your insurance provider while you have an escrow loan account, you just have to ensure that you have canceled your existing insurance policy and provided the details of the new policy to your lender. This is important so that your lender can revise your monthly payments as per your new insurance premium.
On the other hand, you cannot change your property tax assessor as borrowers do not have the flexibility to choose that. What you can do is contest the assessment and have it re-evaluated.
If you refinance your mortgage loan with your existing lender, your escrow account stays intact, just the terms are revised based on the new loan terms. However, if you refinance with a new lender, your old escrow account will be closed and settled with your old mortgage being paid off. The remaining balance in your old escrow account will be given back to you and your new lender will start a new mortgage for you. Your new lender may or may not require you to have an escrow account, depending on your loan agreement and terms.
Private Mortgage Insurance (PMI) is typically not factored into escrow and is paid separately. PMI is a type of insurance that protects the lender in case the borrower defaults on the loan. Borrowers are generally required to pay PMI if their down payment is less than 20% of the home’s purchase price.
An escrow fee is a charge associated with the use of an escrow service during a real estate transaction. This fee is paid to a third-party escrow company or an escrow agent who facilitates the transaction and ensures that all parties involved meet their contractual obligations. The escrow fee covers the administrative costs and services provided by the escrow agent. Typically, this fee is a small percentage of the closing cost of the borrower’s home.
Every lender has different conditions under which an escrow account can be closed. However, some types of escrow accounts like those created for FHA and other government-backed loans typically require the borrower to maintain the escrow account for the life of the loan. For private lenders though, the conditions can be outlined and explained to the borrower.
For example, if you’ve reached a specific equity threshold in your home, often around 20%, you may be eligible to request the cancellation of your escrow account. This threshold is typically tied to the loan-to-value ratio (LTV) of your mortgage.
Or, some lenders also require borrowers to maintain an escrow account for a certain period or under specific conditions, such as a history of late payments or financial instability. Before closing your escrow account, ensure that you meet all requirements set by your lender.
The costs associated with escrow closing typically include costs for the services the escrow company or individual escrow agent has provided. This includes everything from setting up the third party account, holding funds, handling tasks, escrow fee, title insurance, title search and closing fee, etc.
Lenders often utilize mortgage escrow software to automate and streamline the borrower escrow process and ensure accurate, efficient escrow management. And Bryt Mortgage Escrow Software is leading the way. With Bryt, lenders can calculate escrow amounts without errors and manage escrow accounts stress-free:
Escrow accounts can feel complex at first, but you are not alone. Majority borrowers have similar questions as addressed above. By understanding how escrow works, the benefits it offers, and the potential drawbacks, you can make informed decisions about your mortgage and ensure a smooth homeownership journey. And if you find lenders utilizing the Bryt Escrow Management Software know that you are in the right place.
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