What is a Mortgage Escrow Account?

You’ve likely heard of an escrow account, especially if you have a home mortgage. But if you don’t have a home mortgage, or you don’t quite fully understand your current escrow, we’ve put together the following to help you better understand the ins and outs of it.

What is a mortgage escrow account?

When you own a home, you're responsible for additional home-related expenses like property taxes and insurance. Escrow accounts help you plan for those payments and make sure you have the money set aside for them so you don't have to think about it.

Why is an escrow account important?

Most people find that it is easiest on their pocketbooks to pay their taxes and insurances simply as a part of their monthly mortgage payment. It can be hard to remember to set aside money every month on their own so that there’s enough to pay those bills when they come due every year. And it is really easy to dip into those funds to pay other bills if the money is sitting in your desk drawer or an easily accessible savings account with online and mobile banking.

So, look at an escrow account as a form of forced savings, assurance that the bills will be paid on time without penalty or late fees.

Who needs an escrow account?

This one depends on a few factors. You don’t have to have an escrow account, but there are a lot of benefits and safety measures that come with it. If you’re not great at saving and disciplined with your finances, it’s best to have an escrow account. This way your lender will be responsible for making the payments on time. They will also be responsible for any penalties should a payment be late. This means you can avoid concerns like lapse of insurance coverage, a lien on your home, or penalties yourself.

If you do feel comfortable managing and saving to pay these necessary fees yourself, your lender will make sure you’re in a good financial position to cover what you need. Banks will use a Loan-to-Value ratio to determine if an escrow is required or not.

The general rule-of-thumb is if you have less than 20% equity as a homeowner, you will be required to have an escrow account.

How does an escrow account work?

An escrow account is set up to collect your payments for property taxes, homeowners insurance and possibly other items, in equal amounts over a 12-month period, to be paid on your behalf when those bills come due.

Regulation requires a formula for banks to use so everyone’s escrow is calculated the same. To get an idea what your monthly escrow payment will be, simply add up all these charges and divide by 12. For example, if your annual tax bill is $2,400 and your insurance is $1500 a year, then your escrow payment will be $325.00, or $3,900 divided by 12.

Also realize that the law allows lenders to maintain a “cushion” of no more than one-sixth of the total amount paid out of the account — two months’ worth of payments — so that the escrow account always has a balance. And realize that your escrow payment could change every year if your taxes or insurance costs go up or down, or if the cushion amount needs adjusting.

Does having an escrow account mean my mortgage payment goes up every year?

If you have a ‘fixed-rate’ mortgage what you pay on your loan will never change. However, your loan goes through an annual analysis and looks at what your escrowed bills were last year and what they are projected to be this year. Many times, the escrowed bills change. So, if your property taxes or insurance or both increase, your payment will increase so that there is enough money to pay those bills the next time they come due. On the flip-side, if your taxes or insurance decrease and you have too much money in your escrow account, you’ll receive a refund.

To learn more about escrow and our home mortgage offerings, contact Home State Bank and ask for our Mortgage Specialist Amy Milligan (NMLS #1092551).

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