What Is an Escrow Analysis and How Does It Work?

An escrow analysis is a routine financial review for homeowners with mortgage loans. This process evaluates the funds collected and disbursed from an escrow account over a specific period, typically a year. Its primary purpose is to ensure that monthly contributions cover property-related expenses paid through the account.

Understanding Your Escrow Account

An escrow account is established by a mortgage lender or servicer. This account holds funds collected from the homeowner as part of their regular monthly mortgage payment. The funds typically held in an escrow account include property taxes and homeowner’s insurance premiums. Other expenses like private mortgage insurance (PMI) or flood insurance may also be included, depending on the loan terms and property location.

Lenders require escrow accounts to protect their investment in the property. If property taxes are not paid, a tax authority could place a lien on the home, potentially leading to foreclosure. Similarly, if homeowner’s insurance lapses, significant damage could decrease the home’s value, impacting the loan’s collateral. By managing these payments, the escrow account ensures these expenses are paid on time, safeguarding both the homeowner’s asset and the lender’s interest.

This system simplifies financial management for homeowners. It breaks down large, infrequent expenses into smaller, more manageable monthly contributions. Instead of needing to save and pay thousands of dollars in a lump sum for taxes or insurance, the cost is spread evenly throughout the year. The lender or servicer then disburses these funds directly to the tax authorities and insurance providers when the bills are due.

The Escrow Analysis Process

Mortgage servicers conduct an escrow analysis to assess the financial health of the homeowner’s escrow account. This automatic, periodic audit compares the funds collected against the actual and projected costs of property taxes and insurance for the property. Its goal is to determine if the homeowner’s monthly escrow contributions are appropriate to cover upcoming expenses for the next 12 months.

This process involves several key steps. The servicer first reviews the actual expenditures for property taxes and insurance premiums from the previous year. They then project the anticipated costs for the upcoming year, taking into account any known changes in tax assessments or insurance rates. Finally, the servicer compares these projections to the current balance in the escrow account and the homeowner’s planned contributions to ensure adequate funds will be available.

Federal law, the Real Estate Settlement Procedures Act (RESPA), mandates that mortgage servicers perform an escrow account analysis at least once a year. This annual analysis typically occurs around the anniversary of the loan’s first payment. RESPA also permits servicers to maintain a cushion in the escrow account, generally limited to about two months’ worth of escrow payments. This cushion provides a buffer against unexpected increases in property taxes or insurance premiums throughout the year.

The analysis can result in one of three outcomes: a surplus, a shortage, or a deficiency.

A surplus occurs when the analysis shows that the amount in the escrow account, including the allowed cushion, exceeds the projected disbursements for the upcoming year. This means the homeowner has paid more than was necessary.

A shortage indicates that the projected balance in the escrow account will fall below the required minimum balance or cushion at some point during the next 12 months. This situation arises when the actual costs of taxes or insurance were higher than initially estimated.

A deficiency represents a more significant imbalance, where the escrow account actually has a negative balance. This occurs if the servicer had to advance funds to cover bills when the homeowner’s contributions were insufficient.

Interpreting Your Escrow Statement and Actions

Upon completion of the annual escrow analysis, your mortgage servicer will send you an escrow analysis statement. This statement provides a detailed breakdown of your escrow account’s activity and projected future needs. It typically includes a summary of the previous year’s actual payments, a projection of expenses for the upcoming year, and a calculation of your new monthly escrow payment. It also highlights any surplus, shortage, or deficiency identified during the analysis.

If the statement indicates an escrow surplus, it means you have overpaid into your account. If the surplus is $50 or more, the servicer is required by RESPA to refund that amount to you within 30 days. For surpluses less than $50, the servicer may either refund the amount or credit it toward your next year’s escrow payments. Your overall monthly mortgage payment may also decrease as a result of the lower required escrow contribution.

An escrow shortage means there was not enough money collected to meet the projected costs for the previous period or the required cushion for the upcoming period. The servicer will offer options to address this. You may choose to pay the full shortage amount in a lump sum, or the servicer might automatically spread the shortage repayment over the next 12 months, increasing your monthly escrow payment for that period.

A deficiency signifies that your escrow account had a negative balance. This often results in a required lump sum payment to bring the account back to a positive balance and meet the necessary cushion. Similar to a shortage, the servicer may allow this amount to be repaid over a period, typically 12 months, which will also increase your monthly mortgage payment. Your new monthly payment will reflect the updated projections for taxes and insurance, plus any amount needed to cover a shortage or deficiency.

If you believe there is an error or discrepancy on your escrow analysis statement, you have the right to dispute it. Carefully review the statement, checking for any payments not credited or incorrect disbursement amounts. Gather supporting documentation, such as property tax bills or insurance premium notices, that contradict the servicer’s figures. Contact your mortgage servicer in writing to request a reevaluation and provide copies of your evidence.