All mortgage lenders use the same escrow account calculations. In other words, it doesn’t matter what lender you choose since the prepaids will be the same regardless of mortgage program or loan terms.
Check out our escrow account overview as a precursor to this article about escrow account calculations. You may also want to check out our page on escrow analysis and rebalance to learn about the escrow evaluation and re-balancing that takes place annually.
Escrow Account Overview
A homeowner funds an escrow account at the closing and funding of a mortgage. The mortgage servicer manages the escrow account. An escrow account pays both property taxes and homeowner’s insurance on behalf of the homeowner.
Homeowners may be able to waive escrows when doing conventional mortgages or jumbo loans. The escrow account calculations are not applicable when escrows are waived. Conversely, Government-backed loans (i.e. FHA, VA, and USDA) mandate an escrow account.
Escrow Account Calculations
Escrow account calculations differ for purchase and refinance home loans. Likewise, different states have their own escrow account calculations. The examples below are for purchase mortgages in Texas.
Refinance escrow account calculations are loan specific. They are a product of the month the loan closes and when the insurance renews. Please visit the refinance escrows article for more details on refinance escrow account calculations.
Remember, prepaid amounts are the same regardless of the lender. The reason for this is because the homeowners selects the homeowner’s insurance and the property taxes are determined by the home’s value and local tax rates.
When shopping for a mortgage, compare the amounts used for the estimated taxes and insurance. Unscrupulous lenders purposely use low estimates to show artificially lower closing costs. Remember, the bottom line for prepaids will be the same for all lenders.
Purchase Loan Escrows
The escrow account calculations for purchase loans is essentially 12 months of homeowner’s insurance, 3 months of additional insurance, and 3 months of property taxes.
By comparison, waived escrows means the three extra months of taxes and three months of insurance are excluded at closing; only the 12 months of insurance is collected.
First Year’s Insurance
The homeowners pays the first 12 months of homeowners insurance at closing. Immediately after closing the title company will disperse that first year’s premium directly to the insurance provider.
Three More Months for Insurance
Escrow account calculations show that the homeowner pays an additional three months of homeowner’s insurance at closing. This three-month cushion is held in the escrow account. This excess cushion accounts for future increases in the insurance premium.
Example: A purchase loan closes on July 1st. The first payment will be due September 1st. Two of the three months of insurance cushion essential fills in the “gap” for the non-payment months of July and August.
Afterwards, the monthly payments from September through June the follow year will total ten payments. The mortgage servicer can pay the insurance renewal the following June with those 10 payments and the three months cushion. In fact, they’ll even have a little left over to account for increased insurance premiums.
Three Months for Taxes… Sort Of
We told a little fib above and said the escrow cushion is three months of property taxes. That’s not entirely.
The amount of property taxes collected from the buyer on the Closing Disclosure (CD) will be more than three months. BUT the sellers will reimburse the buyer for their prorated portion of property taxes. The net out-of-pocket costs is approximately be three months.
Example: A purchase loan closes on July 1st. The Closing Disclsoure will show 9 months of property taxes collected from the buyer. One page 1 the sellers will reimburse the buyer for their prorated amount of the taxes.
In this examples the sellers reimburse the buyer for 6 months since they owned the home from January 1st through July 1st. This makes the buyer’s net out of pocket about three months of taxes.
Escrow Taxes Collected When Taxes Are Due
For closings that occur when the property taxes are due (typically between October 1st and February 1st in Texas) the aforementioned information is still true but the numbers may appear differently on the CD. This is where the escrow account calculations get tricky.
In Texas, property taxes are due in early October, but homeowners have until January 31st the following year to pay the bill before considered late. Taxing authorities will only accept one payment for the full amount of taxes. The responsibility of payment lies with whoever owns the home at the time the taxes are due.
If the taxes are not due at the time of closing on the purchase, the buyers will be responsible for making the full year’s property tax payment when the bill is due later in the year.
Conversely, if the property taxes are due at the time of closing, the seller will pay for the full year of taxes on the Closing Disclosure. The buyer will then reimburse the seller for the prorated remaining time that they’ll own the home during the year.
Example: let’s assume that the seller has already paid the annul property tax bill for a purchase closing December 1st. At closing, the buyer will reimburse the seller for the their portion of the year’s bill; in this case it’s one month (December 1st through December 31st). The buyer would then pay approximately two months of taxes to start the “cushion” for the escrow account; hence paying a net of about three months of taxes.
Escrow Account Calculations: Aggregate Adjustments
The federal government determines the escrow account calculations, and occasionally the estimates don’t balance. Because of this, an aggregate adjustment is required.
An aggregate adjustment is a credit to the buyer for an amount that is in excess of what’s allowed to be collected at closing. This credit simply reduces the amount collected for the escrow account and is a line item on the CD. The formula is too complicated to cover here, but know that Uncle Sam has you covered. As always you’re welcome to call us if you have any questions about an escrow account. We’re here to help.
Loan Officer, NMLS # 729612