Many homeowners are surprised when a letter from their mortgage servicer announces a new monthly payment, even though they have a fixed-rate loan. The interest rate has not changed, and neither has the loan balance schedule. What has changed is the escrow portion of the payment, the money your servicer collects to pay property taxes and homeowners insurance on your behalf. Understanding how escrow works makes these changes far less confusing and much easier to plan for.
When you make a monthly mortgage payment, it often covers four things: principal, interest, property taxes and insurance, sometimes shortened to PITI. Principal and interest go toward the loan itself. The tax and insurance portions are deposited into an escrow account, a separate holding account managed by your servicer. When your property tax bill or insurance premium comes due, the servicer pays it from that account, so you do not have to come up with a large lump sum once or twice a year.
Why lenders require escrow
Unpaid property taxes can lead to a tax lien on the home, and a lapse in insurance leaves the property unprotected. Because the home secures the loan, lenders want to be sure those bills are always paid. Escrow is commonly required for government-backed loans such as FHA loans, and for many conventional loans when the down payment is less than 20 percent. Some borrowers with more equity can choose to pay taxes and insurance themselves, although lenders may charge a small fee or require a strong payment history to allow it.
The annual escrow analysis
Once a year, your servicer reviews the account. It looks at what was actually paid out over the past twelve months and estimates what will be needed for the coming year. Federal rules allow the servicer to keep a cushion of up to one-sixth of the expected annual payments, roughly two months' worth, to cover small increases. If your county raises property taxes or your insurance premium goes up, the estimate rises and so does your monthly payment.
For example, if your annual property taxes increase from $2,400 to $2,880 and your insurance rises from $1,200 to $1,440, your yearly escrow need grows by $720. That alone adds about $60 a month to your payment, and if the account was short last year, the servicer will also ask you to make up the difference.
A higher mortgage payment on a fixed-rate loan is almost always a change in taxes or insurance, not in your loan.
Shortages, surpluses and your options
If the analysis shows a shortage, the servicer will usually let you repay it in one lump sum or spread it over the next twelve months. Paying it at once keeps your new monthly payment lower, while spreading it out avoids a single large bill. If the account has a surplus, generally more than $50 above what is needed, the servicer must refund it to you, typically within 30 days of the analysis.
You are not powerless when costs rise. Review your property tax assessment and file an appeal if the assessed value seems too high. Shop your homeowners insurance every year or two, compare deductibles and ask about bundling discounts with auto coverage. If you receive an exemption, such as a veteran's or senior property tax exemption, make sure your county and servicer have the paperwork. Each of these steps can reduce the amount that flows through escrow.
If your escrow statement is hard to read or your payment jumped more than you expected, the Mortgage Loan team at Trust Finance Solution can walk through it with you line by line. We can also review your insurance coverage and help you decide whether refinancing or a different payment strategy makes sense for your budget.