As a first time home buyer, it is highly likely that any home loan lenders you work with will require an escrow account. Setting up an escrow account is nothing new—but it is a concept you’ll want to understand. Generally speaking, an escrow account is one set up with funds put aside to pay for property taxes and your newly acquired home insurance.
The term and use of an escrow account can also come into play during the home buying process itself! Here’s what first time home buyers need to know about escrow with insight from top home loan lenders in Texas and Virginia.
Different Types of Escrow Accounts
There are two main types of escrow accounts you will likely encounter. The first comes from your real estate agent and attorney as part of the home-buying process. When you go to buy a home, you are likely to need to establish an escrow account. This will be an account where you will place earnest money towards the purchase of the home.
Say you want to buy a home that is worth $400,000, and the buyer accepts your offer. Between the point of the purchase and closing, you will likely need to put a percentage of that purchase price into an escrow account. In the event you back out of the sale or something goes wrong, you may not get that earnest money back. This is why we encourage a home inspection with every purchase.
If all goes as planned, that earnest money comes off the amount you bring to the closing.
The second type of escrow account is one that you will set up when working with home loan lenders. This account will behave more like a ‘savings account’ you put money into monthly. If using the right formula for your ‘savings,’ there should always be enough in the escrow account to pay for the property taxes and home insurance on your new home.
Developing the Initial Escrow With Home Loan Lenders
Upon completion of the home closing and setting up your mortgage, your mortgage lender will need you to pay in a certain amount to set up your initial escrow balance. This will be a large enough dollar amount so that any home loan lenders you work with can be sure they can pay for your home insurance and real estate taxes when necessary. From there, it will be a monthly payment that you will make to replenish the escrow account.
Calculating the Escrow Payment
- As we outlined above, when you pay your mortgage monthly, you will be placing a portion of that payment into an escrow account.
- Your mortgage lender will do a calculation to determine what that payment is monthly, and it can change from one year to the next.
In a basic example, assume you have home insurance costing $1,000 and real estate property taxes also costing $1,400 annually. In total, that is $2,400 in expenses your mortgage lender will be paying on your behalf. On a monthly basis, they will likely have you paying $200 into your escrow account so that they have the funds necessary to pay those fees for you.
The Impact on Your Mortgage
When you have an escrow payment as part of your mortgage, this is where you start to hear the term ‘PITI’ mentioned. This stands for principal, interest, taxes, and insurance. Your monthly mortgage payment will include the principal payment against your mortgage, the monthly interest based on your mortgage interest rate, as well as an escrow payment that allows for your mortgage lender to pay your taxes and insurance.
The Annual Escrow Analysis
Your mortgage lender will not leave you with a static escrow payment from one year to the next: it is typical for home insurance as well as real estate taxes to fluctuate from year to year. As this happens, home loan lenders will do an analysis of your monthly payment in relation to what they expect your real estate taxes and home insurance to be in the year ahead.
When they do this analysis, they will end up with an escrow shortage or an overage. If you have a shortage, you will increase your monthly escrow payment, or you will pay a lump sum to settle the shortage. If you have an overage, it will reduce your monthly escrow payment.
Federal regulations say that your mortgage lender can only keep an amount in your escrow that is equal to your home insurance for the year, property tax bills, as well as two extra monthly payments and an extra $50. If they have more than this in your account, you can expect a check in the mail to settle the escrow surplus.
Whether you are shopping for a home in Virginia Beach, VA, or Plano, TX, you want to have a complete understanding of the mortgage process and where an escrow payment fits into the equation. Working with only the best home loan lenders you can trust helps to paint a better picture of where that escrow payment comes from.
We know you can’t afford to be unclear on the terms of your mortgage and how it will impact you. That’s why we developed a clearer path at the HomeSoon Lending Team to get you home sooner! Just reach out to us, and one of our top loan officers will be happy to guide you through the intricate details of your home purchase—including the importance of getting prequalified!