Just what is an escrow account and what does it do? Good questions.
You establish an escrow account when finalizing the purchase of your home, and a portion of your monthly loan payment is added to the account until the loan is paid in full. Your property taxes and homeowner’s insurance are paid from the account when due each year.
Escrow makes those obligations more manageable for homeowners since the payments are spread throughout the year versus coming due all at once. Plus, the mortgage servicer makes sure the bills are paid on time.
The mortgage servicer conducts an escrow analysis every year to determine whether there are any adjustments to your property taxes or homeowner’s insurance. If there is an increase for either one, it could mean there’s a shortage in your escrow account. You may still have a balance in the account but it’s not enough to cover those expenses.
You can anticipate an escrow shortage by studying the property tax assessment you receive from your county every year as well as potential increases in hazard insurance. If you owe more taxes or insurance, you will likely need to make up the difference in your escrow account.
An escrow shortage is also common with newly constructed homes. This happens because the tax assessment in the first year is an estimate and can be considerably less than how the home will be assessed once completed. Be prepared to have your monthly payment increase as a result.
To keep your monthly loan payment lower, you might want to avoid an escrow account. However, you will need to manage your property taxes and homeowner’s insurance on your own.
Your lender can work with you to determine which mortgage can be structured in that way. For example, FHA loans require that buyers use an escrow account to ensure their taxes and insurance are paid when due. Conventional loans and Veteran’s Administration (VA) loans require a larger down payment and/or stronger credit scores if you want to avoid escrow.
Always ask your lender to explain every aspect of your mortgage, including terminology you don’t understand. It’s part of the personal service you should expect for what could be the most valuable purchase of your life.