New Construction Escrows
New construction home loans that have an Escrow Account could potentially experience a dramatic increase in a monthly mortgage payment after an Escrow Analysis is preformed depending on how the property tax portion of the escrow account is initially determined.
How To Prevent A Payment Increase
A new construction home loan with an escrow account can be subject to having a significant increase in monthly payment after the first year depending on how the escrow account was setup at closing. It’s prudent to ensure that your lender is basing your initial escrow account on the estimated property taxes for the improved property (i.e. the sales price) and not the unimproved value (i.e. the lot value). This will most likely result in an escrow surplus but it will ensure your future payments are comparable after an escrow analysis is conducted.
Worst Case Example
If a newly constructed home is purchased in June of 2014, the county will most likely base the property’s value off the unimproved value (i.e. the lot value) since the counties conduct their value assessments in the first few months of a year. In this example let’s use a $50,000 value for the land and assume that property tax rate is 2.4% which makes the annual taxes $1,200 per year.
A $400,000 home with a 2.4% tax rate would have a $9,600 annual tax bill (or $800 per month); however, the first year’s tax bill for the newly constructed home will only be for $1,200 (with the taxes based off the land).
If the lender established the new escrow account using the unimproved property taxes (i.e. the $100 per month), the borrower’s payment will significantly increase once the lender does an escrow analysis a year or two later and realizes the escrow shortage. At that time the Mortgage Servicer will:
- increase the monthly payment by $700 per month to account for the property taxes going from $100/mo to $800/mo, and
- require the full amount of the escrow shortage to be paid in a lump sum OR increase the monthly payment to recoup the shortage over a twelve month period.
In the aforementioned example, when the taxes come due at the end of 2014 the $1,200 property tax bill will be paid and the escrow account will be “in balance” since the payments for taxes are based off that unimproved assessment of $1,200.
In early 2015 the county will do a property value assessment and most likely determine the new value of the home to be something near the sales price of $400,000. At this time the Mortgage Servicer may be unaware of the potential issue because there’s no escrow shortage. Then at the end of 2015 the property tax bill of $9,600 will come due but there will be a deficit in the escrow account since only $100/mo has been collected for taxes since the home’s purchase. The Mortgage Servicer will ultimately pay for that deficit to prevent the county from placing a tax lien on the home.
Then in early 2016 – a year and a half after the purchase’s closing – an escrow analysis will be done by the Servicer and it will be determined that there is a $8,400 deficit. The Servicer will then send a letter notifying the homeowner that the $8,400 is due and payable AND that the monthly payment will increase by $700 for the new tax value. If the borrower is unable to pay for the shortage the Servicer will most likely increase the payment by another $700 per month to recoup that $8,400 deficit over twelve months. This means the payment could potentially increase a total of $1,400 per month. No bueno.
A Lessor Worst Case
A lesser worst case example would be if the home was partial completed during the county’s value-assessment so that the unimproved value could be closer to the improved value of the home. Everything from the aforementioned example would pertain to this – the only difference would be that the escrow tax payments would be off a higher value and reduce the future deficit.
As always, please feel free to call us if you have any questions. We are here to help.