Your monthly mortgage statement shows that in addition to paying principal and interest, you are also funding your escrow account. What is the escrow account? How is the money in it used? Can it change your monthly mortgage payment? Here’s how your mortgage escrow account works.
Setting aside for essential costs
If you have a mortgage on your home, you will owe money each year for property taxes, homeowners insurance, and—if you put down less than 20 percent on your home at purchase—mortgage insurance. Your lender wants to ensure these payments are made on time, so it generally collects funds for them each month and puts them in the escrow account.
To determine how much goes into the account each month, your mortgage company divides the annual total for expected property taxes, homeowners insurance premiums and mortgage insurance premiums by 12 and adds this amount to your monthly principal and interest. In other words, your monthly mortgage payment equals principal + interest + the monthly portion of property taxes + the monthly homeowners insurance premium + the monthly mortgage insurance premium. The escrow account holds the portion of your mortgage payment associated with the last three items.
Because property taxes and homeowners insurance premiums increase, mortgage companies often want you to have the equivalent of two additional monthly escrow payments as a cushion.
Can the escrow account change my monthly payment?
Your monthly principal and interest payments are fixed unless you have an adjustable-rate mortgage. However, as property taxes and insurance premiums spiral upward, the payment to your escrow account can and often does change yearly.
Increases in the value of your home can also change the portion of the escrow account devoted to mortgage insurance. Once your home’s appraised value increases to the point that your mortgage balance is less than 80 percent of that value, you can apply to your mortgage company to stop paying for this insurance, thus lowering your escrow payment.
Must you have an escrow account?
Sometimes, mortgage companies allow borrowers to pay their taxes and insurance independently without an escrow account. This is a risk for the mortgage company because it means depending on the borrower/ homeowner to be disciplined about saving to pay the taxes and insurance payments when they are due. If the homeowner doesn’t do that, the property could go uninsured or the homeowner could default on property taxes.
Related – An Inside Look at Your Monthly Mortgage Payment
