This article is applicable to homeowners that have a mortgage with an escrow account. Every year mortgage servicers do an escrow analysis on existing escrow accounts.
The result of the escrow analysis may be an increase in the mortgage payment (even if the loan has a fixed interest rate). New construction escrows are the primary reason for unexpected (and dramatic) increases in the monthly payment.
Escrow Analysis And Rebalance
Mortgage servicers conduct an escrow analysis annually to monitor the escrow cushion amount. The federal government requires a specific amount of reserves in an escrow account.
An escrow account calculation determines the amount required to fund an initial escrow account. This establishes a financial cushion that equates to approximately three months of both taxes and insurance payments. This reserve helps cover costs for future increases in property taxes and homeowners insurance.
Mortgage servicers may adjust the monthly payment once per year based on the results of the escrow analysis. The monthly payment will only change as it relates to taxes and insurance. The servicer cannot modify the loan terms – such as interest rate, loan amount, etc..
The escrow analysis will determine if there is a surplus or shortage in the account. The mortgage servicer will then adjust the monthly payment accordingly.
An escrow shortage will most likely occur as property taxes and insurance premiums increase over time. These gradual cost increases will slowly deplete the escrow account’s reserves. Eventually the escrow account won’t have enough funds to pay the taxes or insurance obligations.
A mortgage servicer will typically offer two options to the homeowner if the escrow analysis determines there is an escrow shortage. It’s the homeowner’s decision whether to write a check to cover the shortage or pay the shortage over a twelve-month period.
Option 1: write a check
A homeowner can write a check to the servicer to cover the immediate escrow shortage. Subsequently, the mortgage servicer will increase the monthly payment based on the currently estimated taxes and insurance amounts.
Option 2: add the shortage to the monthly payment
Based on their escrow analysis, a homeowner can elect to add the escrow shortage to the future monthly payments. This means one twelfth (1/12) of the shortage amount will be added to the next twelve payments.
Keep in mind that the mortgage servicer will also increase the payment by the recent escrow increase. This makes it a double whammy. The monthly payment increases due to both the natural increase in escrow amounts, plus the artificial increase due to the 1/12th payment plan.
Escrow Shortage Example
Assume a homeowner’s property taxes increased $1,200 per year and caused an escrow shortage of $600. The homeowner decided not to write a check for the $600. Instead, the homeowner opted to increase the payment by $150 per month.
The first $100 accounts for the permanent $1,200 increase. The next $50 recoups the $600 shortage over a 12 month period.
Assuming the taxes and insurance amount stay the same for the following year, the payment would then be revised downward by $50 since that $600 has been repaid.
While rare, it is possible that an escrow analysis reveals that an escrow account is over funded. When property values, tax rates, or insurance premiums decrease there could be a surplus in an escrow account.
A homeowner is entitled to a refund if there is a surplus in an escrow account. In addition to the refund check, the monthly payments will be lowered if the escrow amounts decreased.
There are (very rare) instances where a refund check is issued to a homeowner in error. Even when the homeowner tried to return the money, the servicer wouldn’t accept it. It was months later when the servicer recognized the errorr and requested the money to be returned.
The lesson: ensure that the refund reason, and amount, both make sense.
The Mortgage Mark Team prides ourselves on educating our clients and ensuring that they know what to expect before, during, and after the mortgage loan process. Explaining escrow analysis is only one small part of that process. Please call us if you have any questions about your escrow account – even if we didn’t originate the mortgage. We’re here to help.
Loan Officer, NMLS # 729612