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Escrow Accounts 101: What They Are and How They Work for Homeowners

If you’re a homeowner with a mortgage, chances are you have an escrow account managed by your lender. But what exactly is an escrow account, and how does it work? 


What Is an Escrow Account?

An escrow account is a dedicated account established by your mortgage lender to cover essential property-related expenses, like property taxes and homeowners insurance. Instead of paying these bills in large lump sums, homeowners contribute to their escrow account in small, monthly increments as part of their mortgage payment. This ensures that your property taxes and insurance premiums are paid on time, without you having to save separately for them.

By managing these expenses on your behalf, an escrow account offers peace of mind and helps prevent financial surprises throughout the year.


Key Components of Escrow Accounts

1. Disbursements: Paying Bills from Your Escrow Account

When your property tax bill or homeowners insurance premium is due, your lender uses funds from your escrow account to make these payments. These payments, called disbursements, happen automatically, ensuring that you stay up to date on property-related expenses. Here’s how it works:

  • Property Taxes: Most property taxes are billed annually or semi-annually. Your lender will use funds from your escrow account to pay this bill on your behalf when it’s due.
  • Homeowners Insurance: Insurance premiums are typically billed annually. By paying from your escrow account, your lender helps ensure your property is adequately insured.

Disbursements are made based on the billing cycles for your taxes and insurance, and your escrow account is carefully managed to ensure that sufficient funds are available when payments are due.

2. Escrow Shortages: When There’s Not Enough in Your Account

At the end of each year, your lender will conduct an “escrow analysis” to review the balance in your escrow account and determine if it was sufficient to cover your expenses. If your escrow account didn’t have enough to cover the costs, this is called an escrow shortage.

An escrow shortage can happen if:

  • Property taxes increase: If your local tax authority raises your property taxes, your escrow account may need more funds to cover the higher bill.
  • Insurance premiums rise: Homeowners insurance rates can also fluctuate, especially if your area has experienced an increase in claims or natural disasters.

When an escrow shortage occurs, your lender will notify you and provide options to make up the difference. You’ll usually have two choices:

  • Pay the shortage as a one-time lump sum: This keeps your monthly mortgage payment the same.
  • Spread the shortage over the upcoming year: Your lender will adjust your monthly payment to account for the shortage, adding a small amount each month until it’s covered.

3. Escrow Surpluses: When There’s Extra Money in Your Account

In some cases, your escrow account may have a surplus at the end of the year. This happens when your escrow payments exceeded the actual amount needed for taxes and insurance.

Surpluses are usually caused by:

  • Decreased property taxes: If your property value decreased, your taxes may have gone down.
  • Lower insurance premiums: A reduction in your insurance rate, due to improvements you made to your home or changes in insurance policies, can lead to surplus funds.

If your escrow account has a surplus, your lender will send you a refund check for the extra amount. By law, any surplus over a certain threshold (typically $50) must be refunded to you. You can use this refund to cover other expenses, make an extra mortgage payment, or save for future costs.

4. Annual Escrow Analysis: Reviewing Your Account Each Year

The annual escrow analysis is an essential process conducted by your lender to review your escrow account’s balance, ensure accurate disbursements, and identify any shortage or surplus. During this analysis, your lender will:

  • Evaluate your total property taxes and insurance premiums for the past year.
  • Compare the actual costs with the amounts collected in your escrow account.
  • Calculate adjustments based on expected costs for the upcoming year.

After the analysis, your lender will send you an escrow statement summarizing any changes. If there’s a shortage, your statement will include details on how much is needed to cover it and your payment options. If there’s a surplus, the statement will show the amount refunded to you.

The annual escrow analysis helps keep your escrow account in line with your actual expenses, ensuring that you’re not overpaying or underpaying.


Coastline Capital Mortgage: Here to Help with Escrow

Navigating escrow accounts, disbursements, and annual adjustments can seem complex, but at Coastline Capital Mortgage, we’re here to make the process simple and transparent. Whether you’re a new homeowner or have questions about your annual escrow analysis, our team is ready to provide personalized support and guidance.

Understanding escrow is one way to feel more confident about managing your mortgage. Reach out to us today to learn more about escrow accounts and how we can help you achieve your financial goals.

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