A part of taking out a mortgage means taking responsibility to keep up with your real estate taxes, homeowner’s insurance, and mortgage insurance premiums. While some mortgage programs allow you to handle those payments on your own, making the large tax payments twice per year (or however frequent your county requires) and your monthly insurance payments, the FHA mortgage program requires that you set up an escrow account, allowing the lender to handle those payments. This is just another way the FHA makes sure that the property stays on the up and up, because if real estate taxes go unpaid, there is a new lien on the house, putting the mortgage in jeopardy.
What is an Escrow Account?
The escrow account is money that you put aside every month for payment of your taxes and insurance. You do not handle any portion of the escrow account with the exception of making your monthly payments. The escrow payments are made right along with your regular mortgage payments, so they are not a separate payment that you have to worry about. At the closing, you will get a breakdown of the principal, mortgage interest, real estate taxes, homeowner’s insurance, and mortgage insurance premium that you will pay every month. These payments all get totalled into one lump sum payment that you make once a month. The lender takes the money that goes towards your taxes and insurance payments and places them in a separate account. When the due dates arrive, the lender makes those payments for you out of your escrow account.
How are Escrow Amounts Figured?
Every lender differs in how much they require in your escrow account. Initially, the lender will need to determine how many months you must catch up in order to have enough in the account to cover the next due date for real estate taxes. Every lender will require some type of “cushion” in the account in order to cover any unexpected increases in taxes or insurance that come up during the year, which will also affect how much is held in your escrow account. From there, the lender determines how much 1/12th of your taxes and insurance payments come out to be. That amount is then added to your mortgage payment. Take the following example:
- Real estate taxes $6,500
- Homeowner’s insurance $900 per year
- Mortgage insurance premium $1,700 per year
This means that the following amounts will be due each month:
- $541.67 for real estate taxes
- $75 for homeowner’s insurance
- $141.67 for mortgage insurance premiums
These amounts add up to the totals for the year. You do not handle payment to any of the agencies – your lender or servicer handles it for you.
Throughout the life of your loan, you will likely see escrow analyses occurring on your loan. The lender does this in order to account for any discrepancies your escrow account sees. In some cases, too much money was collected at the closing or on a monthly basis, which means your escrow requirements might decrease and in other cases, not enough is collected, ending in an escrow shortage, which requires your payments to increase slightly. The first few years are typically a trial and error period until some normalcy is figured out and the right balance is determined.
Canceling the Escrow Account
Unfortunately, for FHA loans, there is no option to cancel the escrow account – you must keep it for the life of the loan, unlike conventional loans which sometimes allow you to cancel the account if you do not have PMI on the loan any longer. If you wish to cancel your escrow account with an FHA loan, your only option is to refinance into a conventional loan once your loan-to-value hits below 80 percent. But you also have to have good credit and enough resources to show that you can pay the taxes and insurance on your own.
Escrow Accounts are not Bad
Many people think of escrow accounts as bad, but they really have many benefits. First and foremost, you are held responsible for your payments. There is no chance at slipping because you met with unexpected expenses and no longer have the money to pay your real estate taxes. This could put you at risk for losing your home, for which escrow accounts are very beneficial. They keep you on track or you run the risk of defaulting on your mortgage payment.
Escrow accounts also provide incredible convenience. Saving for real estate taxes and homeowner’s insurance can be rather daunting and then when you have to add the fact of paying them on time, you can see the convenience that escrow accounts offer. You never have to worry about due dates or whether or not there is enough money. If your escrow account happens to come up short, the lender fronts the money for you so that your payments are made on time and then increase your mortgage payment accordingly on the date of your escrow analysis. You always have the option to contact your mortgage company to ensure that you are on track for your escrow payments and to get a head’s up should your payment be increasing soon.
There is no way around the escrow requirement for FHA loans, no matter how much money you put down on the home. The account is required by law for the duration of the loan. Lenders do not charge money to handle these accounts or make you pay any more than is necessary to cover the fees on your home. Because they keep you on track and able to stay in your home, escrow accounts are a great benefit on a loan. They might make your mortgage payments seem exorbitantly high, but the payments would be the same, no matter if you were paying them to the mortgage company or saving them yourself. Why not have the benefit of knowing your taxes and insurance premiums are always paid on time?