Mortgage escrow account basics aren't always an easy concept for First-time Home Buyers to grasp. One of the most frequent questions I receive from first-time buyers is related to understanding how their mortgage escrow account will work and how much money they'll need to cover this at closing. Many buyers have no clue what you are talking about until you can show them a GFE with all the numbers broken down. So, here's my basic explanation that most clients seem to understand with the first explanation.
Mortgage escrow accounts are special accounts set up by the lender in which money is held to pay for property taxes, fire and hazard insurance, flood insurance, windstorm insurance and private mortgage insurance (if required - loans with less than 20% down payment). Mortgage Escrow accounts ensure that these items are paid in a timely fashion. They are a guarantee that there's always enough money to pay these bills when they are due, so the home owner and lender avoid the risk of lapsed insurance or unpaid property taxes.
With this guarantee, home owners don't have to worry about coming up with large sums of money, each at different due dates throughout the year. Unexpected increases are automatically taken care of by the lender. Mortgage companies typically cover shortages when tax or insurance payments increase. It's very common for lenders to pay the tax and insurance premiums when they are due even though there may be a shortage in the account and they haven't collected it yet from the home owner. When you don't have enough money in your escrow account to cover an increase, this leads to a shortgage in your account. The lender will notify you of this shortgage and generally give the home owner an option of paying the shortage in a lump sum, or spreading the shortgage out over the next 12 months.
Both options will result in an increase in your monthly payment. The latter option will result in a larger temporary increase in your monthly payment and will continue with a level increase afterwards. In this instance, you get hit with the proverbial "double whammy", as you are adding not only the new monthly increase 5to your mortgage escrow account, but additionally paying the shortgage as well. If you are refinancing your mortgage and have an escrow account shortgage, this will result in a higher payoff of your existing balance than you may be anticipating.
Mortgages have lower rates and down payments because of escrow accounts. Mortgage Escrow Accounts protect the interest of investors/lenders of home mortgage loans by making them more attractive and secure as an investment. Local governments save money by providing a more efficient, less expensive means of tax collection. In Florida, where the Counties offer a cash discount up to 4% for paying early, your mortgage company will pay and take the discount on your behalf.
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