When arranging your mortgage payment, you’ll notice various components included. Usually, a monthly mortgage payment comprises principal, interest, taxes, and insurance. These elements amalgamate to form a single payment directed to your lender. However, the lender isn’t responsible for managing property taxes or insurance, correct? So why do they handle these payments? The explanation lies in escrow.
What is an Escrow?
In general terms, escrow refers to the process where one party collects funds to be disbursed to another party later, contingent upon certain conditions being met. This term is commonly encountered during the home buying process. For instance, when you provide an Earnest Money Deposit, the funds are placed in escrow to be utilized for your down payment upon closing and purchasing the home. Typically, a lawyer or another designated entity holds onto these funds until the closing occurs.
After you’ve become a homeowner and commence making monthly payments, a similar mechanism is in place, particularly concerning your taxes and often your insurance.
Your lender issues you a monthly bill covering the actual loan amount. Additionally, they gather payments for your taxes and insurance, forwarding them to your city or county and your insurance company on your behalf. Your statement specifies how much of your monthly payment is allocated to these expenses.
Does Escrow Change?
Every year, your lender reviews your payments to ensure they have collected enough to cover your taxes and insurance. If they have collected an excess amount, they adjust your payments for the upcoming year to collect less. While the principal and interest on your loan remain constant, changes may occur in your taxes or insurance, resulting in a reduced payment.
Conversely, if your lender hasn’t collected enough to cover taxes and insurance, you’ll need to increase your payments for the following year. Additionally, you must address any shortfall from the previous year. Most lenders offer options to address this, such as making a one-time lump payment or incorporating the balance into upcoming year’s payments.
The most common factor influencing changes in your payment is fluctuations in your taxes.
