Should I Cash My Escrow Surplus Check?
Received an escrow surplus check? Understand your choices and their financial impact to wisely manage this unexpected homeowner refund.
Homeowners sometimes receive unexpected checks from their mortgage servicer, identified as an escrow surplus refund. This article aims to clarify what an escrow surplus check signifies and guide homeowners in deciding the most appropriate action for these funds.
Understanding Your Escrow Surplus Check
An escrow account is established by your mortgage lender to collect and hold funds for specific property-related expenses, primarily property taxes and homeowner’s insurance premiums. This arrangement ensures that these recurring, but often large, bills are paid on time, protecting the lender’s investment in the property. Each month, a portion of your mortgage payment is directed into this account.
A surplus in your escrow account occurs when the amount of money collected exceeds what was needed to cover the actual property tax and insurance payments over a given period. This situation commonly arises for several reasons. For instance, if your property’s assessed value decreases, leading to lower property taxes, or if you secure a more affordable homeowner’s insurance policy, the original estimates for your escrow payments might have been higher than the actual costs. Additionally, mortgage servicers conduct an annual escrow analysis, a review required by federal regulations like the Real Estate Settlement Procedures Act (RESPA). If this review reveals an excess balance, typically above a certain threshold like $50, the lender is generally required to refund that surplus to you within 30 days.
Your Options for the Escrow Surplus
When your mortgage servicer identifies an escrow surplus, they will typically issue a check to you, representing the excess funds in your account. You have several distinct choices regarding how to handle this refund, each with different financial implications.
One common choice is simply to cash the check, taking the money as a direct refund for immediate use. This provides immediate liquidity, allowing you to spend the funds as you see fit. Another option involves applying the surplus directly to your mortgage principal. This means the funds would reduce the outstanding balance of your home loan. A third possibility is to apply the surplus towards your future escrow payments. This action uses the funds to offset amounts that would otherwise be collected for property taxes and insurance in subsequent months or years.
Implications of Cashing Your Check
Choosing to cash your escrow surplus check provides immediate access to funds. This can be appealing for various personal needs, such as covering unexpected expenses, contributing to savings, or discretionary spending. Once the check is cashed, the money becomes readily available in your personal bank account.
However, cashing the check has specific financial implications regarding your mortgage. Accepting the refund does not impact your outstanding mortgage principal balance. Consequently, it does not reduce the total interest you will pay over the life of the loan. Your amortization schedule, which outlines principal and interest payments over time, remains unchanged by this action.
Furthermore, while you receive the immediate benefit of the funds, cashing the check does not provide long-term stability for your future mortgage payments. If the surplus was due to a temporary overestimation or a one-time reduction in expenses, your monthly escrow payments could potentially remain the same or even increase in the future, particularly if property taxes or insurance premiums rise again. An escrow surplus is generally not considered taxable income because it is a refund of funds you previously paid. It is essentially a return of your own money, so it does not typically need to be reported on your tax return.
Alternative Uses and Their Benefits
Applying your escrow surplus to your mortgage principal offers several financial advantages. When you make an additional payment specifically designated for principal reduction, it directly lowers the outstanding balance of your loan. This action can lead to a reduction in the total interest paid over the entire term of the mortgage. By reducing the principal, you also accelerate the amortization process, potentially allowing you to pay off your mortgage sooner than originally scheduled. Moreover, paying down your principal more quickly contributes to building equity in your home at a faster rate.
Alternatively, applying the escrow surplus to your future escrow payments can also provide significant benefits. This option can help stabilize or even reduce your upcoming monthly mortgage payments by pre-funding a portion of your property taxes and insurance. It acts as a financial buffer, which can be particularly useful if there are anticipated increases in these costs. Using the surplus in this manner can help prevent potential escrow shortages in the future, which might otherwise lead to a sudden increase in your monthly payment or require a lump-sum payment to cover the shortfall. This ensures that sufficient funds are available for your ongoing property tax and insurance obligations without straining your monthly budget.