Mortgage Escrow Accounts:
What They Are & The Options You Have
The topic of "borrowing power" and questions surrounding "how much home I can buy" are raised almost immediately by prospective mortgage clients during our first conversation together ...
It's understandable and natural. They're excited and anxious. That's especially true when the client is a first-time home buyer.
Most are laser-focused. Their ultimate goal is to find out:
"What's the maximum amount of money I can borrow?" Or when purchasing, the question is often simply, "What price of home can I view?" Again, that's understandable.
But while that information is certainly a portion of what must be discovered and explained during our conversations (and ultimately during the Pre-Qualification/Pre-Approval process), in actuality, it's not the dollar amount or Sales Price of homes they should be most concerned with.
No, their focus and concern should really be on the dollar amount or total Monthly Mortgage Payment they can qualify for. A payment that will be dictated by several things, including:
- The Sales Price of the home being considered
- Real Estate Taxes on that specific property
- The cost of the Homeowner's Insurance coverage needed for that property
- If Mortgage Insurance is needed in order to purchase the home
- If an HOA Fee (Homeowners Association) comes with the specific property being considered
I've touched upon this important topic previously, most recently in my post, "How Buying in a Homeowners Association Can Affect Mortgage Approval and Monthly Payments". But the crux of this post (and others I've written) center around:
can affect your "purchase power" and subsequently,
This is truly the "bottom line" when seeking financing and Mortgage Approval. It's a topic you and I will revisit often as you navigate your search for your home. During your search, I'll make sure you have all the information you need to seek a home that's a good financial fit ... plus provide you sound guidance to help secure a successful Mortgage Approval.
Below you'll find a breakdown showing what comprises a Monthly Mortgage Payment and an explanation of each component:
The basic components:
1. Principal and Interest Payment for the loan (P&I)
Per the Consumers Financial Protection Bureau: The principal is the amount you borrowed and have to pay back, and interest is what the Lender charges for lending you the money
Escrow Accounts typically include these expenses:
2. Real Estate Taxes (1/12th of Annual Tax Bill)
3. Homeowners Insurance (1/12th of Annual Premium)
4. Mortgage Insurance (PMI or MIP, if applicable)
* Note, Homeowners Association Fees: (HOA, 1/12th of Annual Fee, if applicable), are factored into the Housing Expense Consideration for Debt To Income Ratios (But NOT Escrowed), and are paid outside of the Mortgage - typically to a third party Management Company of Homeowners' Association.
Item numbers 2, 3, and 4: Are items considered in the "Escrow".
In the State of Illinois: Escrow means "any account established by the mortgage lender in conjunction with a mortgage loan on a residence, into which the borrower is required to make regular periodic payments and out of which the lender pays the insurance and taxes on the property covered by the mortgage". (Illinois Mortgage Escrow Account Act)
Escrow payments are collected monthly by the Lender (or Mortgage Servicer) via the Monthly Mortgage Payment, then disbursed/paid-out after accruing in the Escrow Account.
- Real Estate Taxes are paid out as tax installments become due during the year
- Insurance is paid upon the annual anniversary/renewal date of the insurance policy
FYI regarding Insufficient Escrow Balances: If the Escrow Balance is insufficient to make a payment, the Borrower is notified, and required to fund the Escrow with a lump sum payment ... or an acceptable increase in the Monthly Escrow Payment to "catch up" on the shortage during the upcoming calendar year.
In most cases: Mortgage Lenders REQUIRE that a Borrower maintains an Escrow Account when they do NOT have a 20% Down Payment (or hold 20% or more Equity in the financed home).
For Borrowers financing in Illinois: Once the Borrower has paid down their Mortgage Balance to 65% of the original loan amount, the Mortgage Lender is REQUIRED TO NOTIFY the Borrower of their Right to Terminate their Escrow Account ... provided that the Borrower is not in default on their Loan.
The Borrower can choose to continue their Escrow Account if that serves their needs best. But at this time, they also have the option of assuming the responsibility for payment of their Real Estate Taxes and Homeowners Insurance (and any HOA Fee) moving forward. (This waiving of Escrow Account should/must be agreed to in writing for the Borrower's protection.)
For Borrowers making an initial Down Payment of 20% or more at the time of financing: These Borrowers have the option of paying into an Escrow Account ... or paying Real Estate Taxes, Homeowners Insurance, and HOA Fees (if included) on their own. This is agreed upon prior to Closing.
For those Borrowers Refinancing their Mortgage: Borrowers refinancing at 80% or less of Appraised Value have the same option to waive Escrow. Again, this must be agreed upon prior to the Closing of their loan.
Escrow ... and how it fits into your home search, home buying, and future Mortgage Payment ... is just one of many things Borrowers need to know and understand. It's important to seek and find a Loan Officer that will take the time to answer questions, fully explain your options, and help guide you through each step of your financing process.
Then you will know upon completion of your Closing that you made informed sound decisions for yourself and financial future ...
* When in need of Mortgage info or service when buying a home in New Lenox - elsewhere in Chicagoland - IL & WI, contact me. I'll be happy to put my 40+ years of mortgage experience and expertise hard to work on your behalf.
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