PURCHASING A HOME?
How An Escrow Account Is Set Up
One thing I always make it a point to cover with clients is escrow accounts when they purchase a home, how they are set up and why, including information on how and when escrow payments can change.
When purchasing a home if you are required to, or choose to, escrow for your taxes and insurance the lender will set up an escrow account to hold those funds until they are payable. On some loan products and higher loan to value loans lenders do require you escrow for taxes and insurance. In my market you may waive the escrow requirement if you have 10% equity on some products. Be sure and ask your loan officer to explain your options.
So, the first question is whether you choose to escrow or whether you are required to escrow. If you are escrowing when you close the lender typically will set up an escrow account to hold the funds until they are needed. These funds are transferred to the lender for your loan after closing.
How is the escrow account set up? When you close on your mortgage loan you need to have a paid up insurance policy covering the home for the first year. I am often asked "if I'm paying the insurance policy up front for a year why am I escrowing for insurance each month?"
You are escrowing each month so the lender will have funds to pay the renewal. You pay up front the first year and the lender pays the renewal each following year when you escrow. (If seller paid funds are negotiated we often use them for the first year premium.)
Assuming you close on your loan in April the policy will renew in April the following year. Closing in April your first house payment will likely be due in June. You can see then that if a renewal is sent out in March of the following year you would only accumulate 9 months of insurance in your escrow account when the renewal comes out. That is WHY you set up an escrow account at closing for about 3 months of insurance, so the lender will have the funds they need to pay the renewal.
What about taxes? If you are escrowing for taxes and insurance you will also add some funds to the escrow account for taxes. This is done for the same reason you set up insurance escrow funds. Usually the seller will credit funds to you at closing for the time they have owned the property and you will skip a month or so before you being making house payments. So you put a few months of taxes in escrow to pay the annual tax bill when it comes out. The months collected can vary because of the variance in when tax bills are due.
When you escrow for taxes and insurance the lender does an annual audit of your escrow account and makes adjustments based on the most current invoices for taxes and insurance. At closing taxes are collected based on the current taxable value. After closing and the next calendar year, in our market, the home is valued at the sale price. So if one buys a home where there is a homestead exemption or a home valued much lower than the sale price then expect an increase in the escrow requirement once the sale price is recorded. And, I don't often see home owner insurance go down so often this is a cause of increasing escrow requirements.