Escrow Explained

By Grant Spencer, Rochester Hills Branch Manager

Escrows on your mortgage can be a beneficial addition to help you manage your monthly budget. Escrows are the annual property taxes and homeowners insurance that are payable annually on a home. Those amounts can be significant and may potentially be difficult to budget for. With an escrow account, the monthly budgeting becomes easier to accomplish.

When you elect to have an escrow account to pay for your taxes and insurance on the home through your mortgage payment, it will allow for and easier budgeting and cash flow experience on a monthly basis. Escrow accounts work like this: the lender takes the total annual amount of the total taxes and home owners’ insurance due annually on the home and divides  it by 12 (months in a year) to come up with a monthly figure. For example, if a person’s property taxes and homeowner’s insurance was $3,600 annually, the monthly amount is $300.  The lender adds the additional $300 per month to your monthly payment so that you can pay them directly through the mortgage at a reduced amount on a monthly basis. This means that the full amount of taxes and insurance aren’t a financial shock when they come due. As an additional benefit, the lender pays the taxes and insurance directly for the escrow account so a member doesn’t need to be involved. The escrow account creates an opportunity to reduce your budgeting stress and create a way to better manage your finances and monthly cash flow.

Your escrow account is an excellent option to help manage your monthly cash flow; however, there are things to be aware of. The lender will collect 1/12 of the known monthly taxes and insurance on the home on a monthly basis to place into the escrow account. However, there can be situations where your taxes go up higher than what is expected. This typically happens most often the year after someone purchases a new home. The lender will use the taxes as they were at the time of the closing of the new home. After closing, the city reassess the value of the home (increasing the taxes). When the lender goes to pay those taxes, they will not have enough in the escrow account to pay for the increased taxes. As a convenience, the lender will pay the increased taxes to make sure they are paid on time. This will reduce the escrow account below its minimum threshold, placing it into an escrow shortage. In this situation, the lender will temporarily increase the monthly payment in order to collect enough in the account to pay for the taxes coming up in the future.

Overall, an escrow account is an excellent option for homeowners, allowing them to more effectively budget a cash flow on a monthly basis.