The Mortgage Escrow Account Explained
Seasoned homebuyers will probably have a fairly good idea of what a mortgage escrow account is. But if you are new to the home buying process, you’ll likely appreciate a detailed explanation of exactly what role a mortgage escrow account plays when it comes to your new home.
A quick definition of escrow…
Simply put, escrow is money or other items of value that is held by a third party on behalf of two other parties engaged in a transaction. The assets are held by the escrow service provider until both parties’ obligations under the terms of the transaction have been fulfilled. At that time, the escrow provider releases the funds or other assets as per the instructions provided when the escrow account was established.
Escrow during the home buying process vs. the mortgage escrow account
Escrow during the home buying process is used to manage funds while the home buyer is under contract and the home sale is pending. During this time, the title company usually oversees the escrow account. But here, we are examining the mortgage escrow account. The mortgage escrow account will be managed after the closing by the lender, usually for the lifetime of the home loan.
Understanding the mortgage escrow account
Each month, a portion of the borrower’s monthly payment will be deposited into the mortgage escrow account. The accumulated funds will be used for paying items such as property taxes and homeowner’s insurance.
One of the benefits of the mortgage escrow account is eliminating the need for homeowners to save for large expenses that come due annually or semi-annually. Instead, the estimated annual expenses are divided into twelve monthly payments, which are baked into the monthly mortgage payment amount.
Calculating the monthly escrow payment is fairly simple. The mortgage lender is required to send the borrower a statement within the first few months after closing showing the estimated annual expenses. It is important to keep in mind that the law does allow for some cushion in this amount.
In addition, borrowers will receive an annual statement detailing the monthly escrow balance, interest and principle paid, and the balance of the loan. The running balance of the escrow account is the reason monthly payments can fluctuate a bit from year to year. For example, if there is a shortfall in the escrow account at the end of a year, the deficit must be made up over the next twelve months. But depositing the shortfall amount as a lump sum is also an option. Likewise, if there is a surplus during any given year, you have the option of requesting a check from the lender, or leaving the funds in the escrow account for safe keeping.
Is the mortgage escrow account mandatory?
In short, the answer is “maybe” – it depends on the lender or underwriter. If your mortgage loan requires that the escrow account is maintained throughout the duration of the loan, there is probably very little you can do to get around it. For example, FHA loans require the escrow account but VA loans do not, although certain requirements do have to be met before the account can be altogether avoided. Some lenders collect escrow payments for the first few years while the principle balance is higher, and then allow you to cancel the account when the balance is paid down.
Do you have questions about the mortgage escrow account and the other costs associated with buying a home? Contact Torrance home loan expert Shawn Carvin today for a free consultation. Shawn is a licensed California mortgage professional with nearly 30 years experience in the financial services industry, half of that focused on mortgage lending. Shawn works with clients throughout the greater Los Angeles area including Torrance, the Palos Verdes Peninsula, the Beach Cities, Lomita, San Pedro, and other South Bay communities, and points beyond.