Lender Escrow Accounts –
When either buying a home or refinancing undoubtedly your lender will force you to have a escrow (impound) account for the purposes of paying your taxes and even perhaps your home owner’s insurance (HOI). Opting out of such an arrangement will often cost you up to a ¼ of a point in your rate. The toughest challenge for most is understanding where this money is going and why.
The Rationale for a Lenders Escrow Account:
When a bank takes a first lien position in your home they want to make sure they are well protected. First they will require that they are protected via your HOI policy. This is easy and doesn’t cost you anything.
Secondly they will require you to sign a property insurance replacement form. This document allows your bank to force place you with a HOI policy if for some reason your current policy lapses or is terminated. More times then not a force placed policy will be much more expensive. For the most part this is a moot point since the lender will actually be escrowing for your property insurance.
Third, the lender will often make it a necessity that they hold an escrow account for the benefit of holding proceeds to pay your HOI and property taxes. Quite simply, the bank wants to make sure its collateral is properly insured and that the taxes never fall delinquent. The escrow account is created at settlement and the starting balance will be shown on the HUD-1 Settlement Statement. Each mortgage payment you make thereafter will include a portion to that is contributed to the escrow account for the purposes of making payments to your insurance provider and local tax collectors office.
How Much Will The Bank Make Us Escrow?
It really comes down to when you are closing versus when the payment (taxes or insurance) is due. If you are purchasing a home the chances are that you are paying a year upfront for your HOI policy and this will be collected on the HUD by your title company. In which case the bank will probably escrow a mere 2 months of HOI for purposes of the following year. Keep in mind mortgage payments are made in arrears, so if you close September 10th, you will most likely not have a normal mortgage payment until November 1st.
Let me break it down: On the HUD-1 the title insurance company will collect mortgage interest from September 10th through the 30th. Then your first payment which would be due on November 1st actually covers the principle and interest payment for October. Then when you make a payment on December 1st, this would represent the interest and principle due on the month of November. Putting it all together your first escrow deposit from a mortgage payment would not be made until November 1. Hence, by the time September of the following year rolls around there will be 13 months of available insurance escrow available to pay the premium and have some reserve.
Similar treatment for property taxes, except for taxes it all comes down to when the taxes are due. Every county through out the country differs. Moreover, some counties actually have their taxes broken up in segments (School Taxes, town taxes and county taxes for example). Just know that the lender is going to be holding enough in reserve to constantly carry a surplus.
Using the example below, the starting balance gets added too after each mortgage payment. It increases, increases and increases more until payments by either the HOI or tax collector are due. Then the balance goes down to only bounce right back up upon future payments into the escrow account.
What if my taxes or home owners insurance policy premium go up or down?
The bank will annually analyze the escrow account and determine if it needs to reimburse you with any of the proceeds or bill you for any shortage.
Where does my escrow account go upon a refinance?
Once a title company pays off your first mortgage, any escrow currently held with your prior creditor will be returned to you within 30 days. Some lenders, especially if you are currently refinancing with the same back, will often credit your payoff with the escrow currently being held.
Closing Costs and Escrow Money:
One tricky concept is the way the HUD-1 reads in terms of your total closings costs. On the 2nd page of the new 2010 HUD your closing costs are tallied up creating a total. One concept that many borrowers and home buyers fail to recognize is that the money held by the bank in escrow should not be factored in when really determining how much the transaction cost you in settlement costs. The money held in escrow is for your benefit. It is there to pay for property taxes and insurance and has nothing to do with the costs associated with your loan or the title insurance.
Example of an Escrow Breakdown at Closing: