What is a Mortgage Escrow Account and Why is it Needed?

When you buy a home using a mortgage, an escrow account is usually set up by your lender in order to help manage your property tax and insurance costs. Rather than having to save up and pay these bills separately, part of your mortgage payment is deposited into the escrow account every month. When your insurance premiums and taxes are due, they can be paid via the escrow account. Normally, your lender will use the funds in the escrow account to pay these bills on your behalf.

Escrow Shortages

It’s not uncommon for property taxes and insurance premiums to change over time, so most lenders will review your escrow account every year to ensure enough money is being set aside to cover the costs. Different lenders may have different methods for ensuring you do not have an escrow shortage, but typically, lenders want their borrowers to have a minimum balance in their escrow account at all times. For example, a lender may require you to have at least two months’ worth of escrow payments in your account. If, at your escrow account’s lowest point, it is below the minimum balance, you will have a shortage.

Again, different lenders may have different ways of handling an escrow shortage, but it’s common for mortgage lenders to require the difference to be either paid in full, or to be paid over time in which they add a portion of the shortage amount to the borrower’s monthly payment.

Setting up and managing your own escrow account? To ensure you do not experience an escrow shortage, make sure you are setting aside enough money each month to cover your property taxes and insurance costs. Remember, these can include homeowners insurance, flood insurance and mortgage insurance.

Escrow Overages

If you have more than the minimum balance in your escrow account, it could be considered an overage. This can happen if the taxes or insurance premiums for the last 12 months were less than expected. In many cases, your lender will send you a refund check for the overage.

Are Escrow Accounts Mandatory?

Some lenders, in some cases do require an escrow account. Escrow accounts first became popular as a way for mortgage lenders to help decrease the number of foreclosures due to borrowers not paying property taxes and insurance premiums. For certain loan types or borrowers with less-than-perfect credit, an escrow account may be required. However, the rules and regulations can vary from lender to lender or loan to loan.

If your lender does not require an escrow account, you may request one to be set up or you can set one up on your own. Discuss the options with your loan officer when you’re ready to get a mortgage.