What Happens If I Pay Extra on My Escrow?
Uncover the true financial implications of adding extra funds to your mortgage escrow. Understand how these payments are processed and their effect on your home finances.
An escrow account holds funds collected by a mortgage servicer to pay property taxes and homeowner’s insurance premiums on time. This arrangement helps protect both the homeowner and the lender by preventing payment lapses.
Understanding Escrow Accounts
Mortgage servicers manage escrow accounts, integrating the costs for property taxes and homeowner’s insurance into a homeowner’s monthly mortgage payment. This comprehensive payment, often referred to as PITI (Principal, Interest, Taxes, Insurance), simplifies financial management by consolidating multiple obligations. Each month, a portion of the payment goes into the escrow account, accumulating funds until tax and insurance bills become due.
The mortgage servicer pays these bills directly from the escrow account on the homeowner’s behalf. This covers large, infrequent expenses like annual property taxes or insurance premiums, reducing the burden on the homeowner to save for and disburse these amounts independently. The monthly escrow payment amount is calculated based on the estimated annual costs of these expenses, divided by twelve. This calculation includes a potential cushion, up to one-sixth of the estimated annual disbursements, to cover unexpected increases or early payments.
How Extra Payments Are Applied
When you make an extra payment to your escrow account, these funds are deposited directly into it. This action increases the balance held within the escrow account, augmenting reserves for future property tax and insurance obligations. For instance, if you anticipate a property tax increase, adding extra funds to escrow can proactively prepare for that higher cost.
Contributing extra money to your escrow account does not reduce the principal balance of your mortgage loan. These funds are held separately and are earmarked only for property taxes, homeowner’s insurance, and potentially other escrowed items like mortgage insurance. Consequently, extra escrow payments will not accelerate your mortgage payoff date.
Implications for Your Escrow Account and Payments
Maintaining an increased balance in your escrow account due to extra payments can lead to several practical outcomes. Mortgage servicers are required by federal regulations, such as the Real Estate Settlement Procedures Act, to conduct an annual escrow analysis. This analysis reviews the previous 12 months of activity and projects the upcoming year’s expenses, comparing funds collected with actual disbursements.
If the annual escrow analysis reveals a significant surplus in your account, often defined as an amount exceeding $50, the servicer is required to refund that excess to you within 30 days. Alternatively, if the surplus is less than $50, the servicer may either refund it or apply it as a credit toward your next year’s escrow payments. This refund or credit can reduce the monthly escrow portion of your mortgage payment for the subsequent year, providing financial relief.
An increased escrow balance from extra payments can also serve as a buffer against unforeseen increases in property taxes or insurance premiums. Should these costs rise unexpectedly, the additional funds in your escrow account can help prevent a shortage. This can mean avoiding a sudden increase in your monthly mortgage payment or a lump-sum payment to cover a deficit.