Does Escrow Ever Go Down? How It Works
Understand how your mortgage escrow account works, why its balance fluctuates, and how lenders manage shortages or surpluses.
An escrow account is established by a mortgage lender to manage property-related expenses. It holds funds collected as part of the monthly mortgage payment. Its purpose is to ensure recurring costs, such as property taxes and homeowner’s insurance, are paid on time.
Components of an Escrow Account
A portion of a homeowner’s monthly mortgage payment is allocated to an escrow account. This amount is separate from the principal and interest components of the mortgage. The funds collected in this account are used by the lender to pay various property-related obligations.
Expenses paid from an escrow account include property taxes and homeowner’s insurance. Flood insurance or private mortgage insurance (PMI) may also be included if required. The lender is responsible for managing these payments, ensuring bills are settled when due.
Factors Causing Escrow Balance Fluctuations
Escrow account balances fluctuate, decreasing and increasing over time. These changes impact monthly contributions. An annual escrow analysis reviews account activity and projects future expenses.
An escrow balance can decrease for several reasons. If a property’s assessed value decreases, property taxes may be lowered. A homeowner might secure a new homeowner’s insurance policy with a lower premium, reducing the amount needed. Sometimes, the lender’s initial estimation of future expenses might have been higher than needed, leading to an overcollection.
Conversely, an escrow balance can increase due to rising costs. Property taxes frequently increase due to reassessments or new levies. Homeowner’s insurance premiums may also rise due to inflation, increased risk, or coverage changes. If the lender initially underestimated the required funds, a higher monthly contribution will be necessary to cover expenses. Additionally, lenders are permitted by the Real Estate Settlement Procedures Act (RESPA) to maintain a cushion, typically up to two months of annual disbursements, to account for unexpected increases.
Addressing Escrow Account Imbalances
The annual escrow analysis may identify an account imbalance. This results in either an escrow shortage or a surplus. These are regular adjustments.
An escrow shortage occurs when the account has less money than required to cover projected property taxes and insurance. If a shortage is identified, lenders offer the homeowner two options to reconcile the account. The homeowner can make a one-time lump-sum payment to cover the deficit. Alternatively, the lender may spread the shortage amount over the next 12 months, adding a portion to each monthly mortgage payment. Even if a lump-sum payment is made, the overall monthly mortgage payment might still increase if the underlying tax or insurance costs have risen.
An escrow surplus means the account holds more money than is needed for the upcoming expenses. When a surplus is found, lenders handle it according to federal regulations. If the surplus amount is $50 or more, the lender is generally required to refund the excess to the homeowner, typically within 30 days of the analysis. If the surplus is less than $50, the lender has the option to either refund the amount or apply it as a credit towards the next year’s escrow payments, which can slightly reduce future monthly contributions.