What are escrows and how do lenders decide how much to collect?
Escrowing your taxes and insurance means that you are including your property taxes and hazard insurance in your monthly mortgage payment. If you’re doing that, an escrow account will be required. An escrow account doesn’t cost you anything. It’s essentially a mortgage savings account that you don’t have access to. So the lender will set up an escrow account that your taxes and insurance will be paid out of. It’ll be included in your monthly payment. A small part of that payment will go towards taxes and insurance to fund the escrow account. Then once a year when homeowners insurance is due it’ll pay out of that account, and it’s the same for when property taxes are due.
So there’s always going to be a balance in your escrow account. Usually it’s positive since that’s how we set it up. Your lender will update your mortgage payment once a year to reflect updated taxes and insurance.
So let’s talk about how we calculate that.
Essentially, the lender always wants to make sure there’s a minimum of two months reserves. So if your homeowners insurance is $50 a month and your taxes are $100 a month, it would be a total of $300. So at the minimum the goal would be to always have at least $300 in that account. That’s just in case you miss any payments, or taxes and insurance change drastically.
why are we pre-paying one year of homeowner’s insurance and collecting an extra 3 months?
Let’s say we close in July. Your first payment isn’t until September 1st. For us to be able to have 14 months of insurance, which is basically paying another year and 2 months reserve, we need to collect 3 months to start your escrow account, and then separately we’re paying you first year of insurance at closing.
With VA loans and most conventional loans you are able to waive your escrow account. If you want to pay your insurance and taxes out of your pocket you’re more than welcome to do so with most of our vendors. Most of our vendors don’t charge fees for that, unlike the banks. Banks tend to charge fees because they like to hold onto your escrow. Most of our borrowers like having an escrow account because it helps you budget monthly over 12 months so you have 12 even payments instead of having a lower mortgage payment and making two big tax payments every year and one big insurance payment once a year. Again, most borrowers prefer the escrow account, but it’s optional for most loans.