Demystifying Escrow Accounts

If you are closing on a home or refinancing, there’s a good chance you’ll come across the words “escrow account” or “impounds” numerous times.

At the most basic level, an escrow account is a savings account that is funded at closing and maintained by your lender so they have funds to pay the property taxes and homeowners insurance for the property they are lending on.

Funds in the escrow account are kept current by the borrower paying into it each month. A portion of every mortgage payment goes into the escrow account, so sufficient funds are available to pay the taxes and homeowners insurance premiums when those payments come due each year.

Why?

The mortgage company wants their asset to be protected. If they can make sure that the taxes are paid and the property is properly insured, their investment (the real estate) is better protected and there is less risk that a tax lien results on the property and/or there is property damage to the home while it’s uninsured.

Pros

Many homeowners like having an escrow account because, as explained above, it acts as a kind of savings account for these larger bills that must be paid annually for you to continue owning your property. Instead of having to stroke a check when the taxes are due, you just let the lender pay the taxes for you. This way, if you budget to be able to afford your monthly mortgage payment, you will in essence be saving for your tax bill and homeowners policy premium simultaneously.

Cons

Depending on the size of your home, the amount of funds in your escrow account is not insignificant, particularly right before one of the bills is due to be paid. Some homeowners dislike the lender being able to make interest on their money in escrow when in theory, that money could be making the borrower interest instead.

Escrow accounts are typically maintained by servicing companies. While not all bad, sometimes servicers make mistakes when handling your escrows. Homeowners tend to dislike having to work with a servicer to sort out escrow issues, which can be anything from an improper overage issued to the borrower, to a missed payment altogether.

Servicers are imperfect, like anything else. By and large most work to efficiently pay your taxes and insurance, but it never hurts to double check behind them. Contact your insurance company to confirm they’ve received payment each year. You can also search the property tax records to verify that the county/local entity where your property is located received payment for the property taxes. Most counties maintain this public information online.

Can I get rid of my escrow account?

The short answer is yes, but it will cost you. Lenders typically require an escrow account be established at closing as a portion of the borrower’s monthly mortgage payment if they are putting less than a twenty percent (20%) down payment on the property. Even if you meet the down payment requirement, some lenders will require the borrower to pay an escrow waiver fee, and/or they may charge a slightly higher interest rate if you choose to forego escrow.

Read the fine print and discuss in detail with your lender the costs (if any) associated with waiving the escrow requirement.

Why does it look like I’m being charged twice for escrows?

A common question I get at closing is why the escrow “closing costs” are so high. It also can appear that borrowers are “being charged double” for escrows as well. This is for several reasons.

First – homeowners insurance premiums are paid in advance. There is typically a 12-month premium that is collected and paid at closing to the insurance company to insure the property for the upcoming year.

Second – property taxes in the Carolinas are paid in arrears. This is the opposite of the insurance. The amount of funds deposited in the escrow account for property taxes will depend on when you close. For South Carolina, the property tax bills come out in October. In North Carolina, the property tax bills come out in late July/early August.

As an example, if you close in the month of August on a SC property, your lender is typically going to collect 11 months worth of property taxes as part of what is called the “initial escrow payment at closing” on the buyer’s Closing Disclosure. Why eleven months? Well, a closing in August typically results in a first mortgage payment due in the month of October, which is the same month that the current tax bill comes out. So that will be one more payment for the taxes, which brings your escrow account to 12 months, or a full year’s worth of property taxes in the account so that the lender can pay the bill once it is received.

Conclusion

Understanding escrow accounts in general and as they apply to your particular property will help ensure a smooth closing process with your lender and your closing attorney. As mentioned above, more expensive real estate requires that higher amounts be escrowed, so it’s important to take the monthly escrow costs into account when determining what real estate you can afford to buy and maintain.