Your Escrow Account

An escrow account is an account typically set up by your lender, which allows you to deposit funds monthly to pay for your future real estate taxes and home owners insurance.  The monthly deposits into your escrow account will come from your total monthly mortgage payment.  In the past lenders would give you the option on whether or not an escrow account would be set up on your behalf, however today most lenders require that an escrow account be established before final loan approval can be had. 

You may notice, at the time of closing, that escrow fees are collected in the prepaid items portion, located on your settlement statement.  These prepaid items will typically be itemized into several individual fees for the purpose of full disclosure.  Most of the prepaid charges listed on the settlement statement will be the escrow fees which will include your real estate taxes and homeowner insurance.  Your taxes and your homeowner’s insurance will be deducted monthly from your total monthly mortgage payment and will be deposited directly into your escrow account.  When your taxes or your homeowners insurance becomes due, your lender will simply withdraw the funds out of your escrow account and pay it to the appropriate parties.  This will continue on as long as you have an established escrow account with your lender.

Understanding how an escrow account works is pretty easy to do.  What confuses most people when it comes to their escrow account is how escrow fees are collected during the initial purchase or refinance transactions.  Well rest assured this is not a difficult topic to understand.  The first thing you should know is that if your lender requires you to have an escrow account, then you will be required to set up a new escrow account at your closing.  Lenders will not transfer your previous escrow balance from one real estate transaction to the other.  The next thing to remember is that your real estate taxes and your homeowner’s insurance premiums are two separate expenses and will therefore have different requirements.  Your escrow account will accommodate each of these expenses throughout the year; however these expenses will be treated differently at closing.   

Most purchase transactions will require the title company to collect 14 months worth of homeowner’s insurance in order to satisfy the lenders escrow requirements.  This may seem a bit high, however since there was no established escrow account to draw from, the title company will have no other choice but to pay the yearly premium on the new homeowner’s insurance policy from the funds collected at closing.  The title company will then collect two additional months reserves to ensure that the new escrow account start off with enough funds to pay for next years homeowners insurance when it becomes due.   

When you refinance your loan you will notice that the homeowner’s insurance fees collected into escrow will fluctuate, depending on your closing date.  The reason for the differences is that the amount collected at closing will be based on when your next homeowner’s insurance policy premium becomes due.  The lender will require the title company to collect enough homeowner’s insurance premiums into reserves in order to establish enough funds to pay for the policy when it does renew. 

The amount collected for your taxes at closing will vary, depending on when and where your loan closes.  However the amount collected should not vary much based on the type of real estate transaction you are closing on.  Your title company will determine the amount collected based on when your next tax installment takes place, which will also be determined based on where you live.  For example, in the state of Colorado, your real estate taxes are paid twice a year, February 28th and June 15th.  Colorado will also allow you to pay your real estate taxes once a year, on or before April 30th.  On the other hand the state of Florida will require you to pay your taxes in full on or before March 31st.  Therefore, the number of months collected into escrow will be based on how many remaining months are left before that due date comes and goes.   

Hopefully by now you should have a good understanding of what an escrow account is and how these accounts are established during the real estate transaction process.  And though you might find this helpful all you really need to know is that your escrow account is used to pay your real estate taxes and homeowners insurance premiums when they become due.  The funds used to support this account are deposited directly into your escrow account from your monthly mortgage payments.