Mortgages are generally made up of four parts: principal, interest, taxes and insurance. Together these comprise what is called HAD TO and complete your total monthly mortgage payment.
Since taxes and insurance are usually paid annually or semi-annually, they are usually held in receivership by the lender or another company servicing the loan. You pay each month on your blocked balance with your regular payment, and your taxes and insurance are automatically paid from this account when they are due.
Key points to remember
- Escrow is when money is held by a trusted third party pending a deal or transaction.
- Mortgage payments generally include a portion held in escrow for property taxes and insurance.
- Many lenders require escrow accounts to protect their investment and ensure taxes and insurance are paid.
- You can’t access the money in your escrow account, and banks generally don’t pay interest on your escrow balance.
- The escrow company will periodically perform an escrow scan, which may result in a change to your monthly payment.
What is an escrow balance?
If your mortgage is locked in, your monthly payment is split into three parts. Two parts go to director and interest, depending on the amount of your loan Amortization schedule. Initially, most of your monthly payment covers interest. Over time, more will go towards your principal.
The third part of your payment goes towards your escrow balance. In many mortgages, funds are blocked to pay property taxes and home insurance. When your taxes or insurance are due, the company servicing the loan will take the money from your escrow balance to pay these bills.
Since your mortgage escrow is based on taxes and insurance premiums, these costs are likely to increase over time. If your monthly escrow payments aren’t enough to cover the difference, you may experience a escrow deficit. In this case, your mortgage agent will automatically adjust the monthly payment accordingly. You will then receive a notice indicating a larger monthly mortgage payment which will remain in effect until at least the next review of the escrow account.
Not all mortgages require an escrow account
Not all banks require you to escrow money for taxes and insurance. Federal Housing Administration (FHA) Loans require an escrow account. This protects the bank’s investment in your property by ensuring taxes and insurance are paid.
You can block your taxes and your insurance even if your lender does not require it. This can simplify budgeting for these expenses.
Can I access the money in my blocked balance?
Typically, you cannot access the money in your escrow balance – this money is held by the lender or loan servicer on your behalf. In most cases, the bank does not pay interest on your escrow balance. The total held in your escrow account is usually included in your monthly mortgage statement or online account information.
Periodic Escrow Analysis
The US government requires lenders to analyze regularly the amount of money in your escrow account. Although most lenders do this annually, they may scan your account more often if the amount you owe for taxes and insurance changes.
During the escrow analysis, the lender calculates the amounts that will be owed for property taxes and home insurance over the coming year. For example, suppose the coming year looks like this:
- January: $2,500 in semi-annual property taxes
- April: $1,000 for risk insurance
- July: $2,500 for the second half of property taxes
With $6,000 in expected annual expenses ahead, the lender will divide that amount by 12 to get a monthly payment of $500 into your escrow account. Government regulations also allow escrow companies to keep an additional amount in your account as a cushion in case of unexpected payments. So, depending on your escrow balance, your monthly payment may be slightly more than your total expenses divided by 12.
When your lender completes their escrow analysis, they will send you a statement, either by mail or in your online account. This statement will detail the results of the escrow analysis and your new monthly payment amount.
Frequently Asked Questions
What’s in my escrow balance?
Your mortgage escrow balance will typically include money set aside to pay property and school taxes as well as home and mortgage insurance premiums. Your mortgage agent pays these bonds from your escrow account on your behalf and periodically reviews the amounts paid to minimize the risk of shortfalls.
What is the difference between Escrow Balance and Principal Balance?
A mortgage’s escrow balance refers only to money set aside to pay obligations such as taxes and insurance that are paid on your behalf by your mortgage agent. Instead, the principal balance refers to the amount of the home loan still outstanding. So with each mortgage payment, your principal balance will decrease a little, but your escrow balance may increase as it accumulates until your property taxes are due.
What happens to the escrow balance if you pay off your mortgage?
If you prepay your mortgage or if it ultimately expires, your escrow balance will be refunded to you and your mortgage agreement will end. It may take up to a month to receive this refund. When your mortgage is paid off, you will become responsible for paying your property taxes and insurance premiums.
Do escrow balances earn interest?
There is no federal mandate that escrow balances must be held in an interest-bearing account, and many do not earn interest. Some states have their own laws that require the payment of interest on these amounts, including: Alaska, California, Connecticut, Iowa, Maine, Maryland, Massachusetts, Minnesota, New Hampshire, New York, Oregon, Rhode Island, Utah, Vermont, and Wisconsin.
Your escrow balance is the amount of money that is held for you in your escrow account (also called an escrow account in some parts of the country). You pay into your escrow account each month as part of your regular mortgage payment. Not all lenders require an escrow account, although many do. Even if your lender doesn’t require it, many people prefer to have an escrow account because it makes it easier to budget for these expenses.
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