Ask Dr. Don By Don Taylor, Ph.D., CFA • Bankrate.com

Excess escrow payments

Dear Dr. Don,
I've had my refinanced mortgage with the same financial institution since 1999. I've kept excess money in my escrow account, sending in extra payments for increases in insurance and taxes with instructions on how to apply the extra payments.

However, at the end of the year I received a check from the lender for the amount of extra money I deposited in escrow, but received notice that my escrow payments would increase due to "estimated taxes" that I was aware of -- thereby the extra payment. I was told that it was the law of this state (New Jersey) to return to the borrower any excess money in escrow. I cannot seem to get a comprehensive answer as to why if this extra payment is sent in the beginning of the year it cannot be applied to any increases in taxes for that year.

Of course, I returned this excess from the escrow check to the lender and requested them to deposit it back into escrow. I don't understand why if there is excess in the escrow account it isn't used for any tax increases. I want to keep my monthly payments consistent throughout the life of this loan; I just don't know how to do this. A friend told me to put any extra payments toward the principal (which I understand but this won't keep my monthly payment stable either).
Please help,
Kim

Dear Kim,
Putting the extra payments toward principal isn't the answer.

You're anticipating tax increases and trying to reserve for them in your escrow account. Using the money to prepay the mortgage will reduce your interest expense over time, but you'll still have to come up with the cash to meet any shortfalls in the escrow account.

The problem is that the mortgage servicing industry is very heavily regulated concerning excess reserves in escrow accounts because of past abuses where they required homeowners to over reserve for taxes and insurance. Excess reserves protect the lender by keeping enough money on hand to pay the taxes or the homeowners insurance bill.

My solution is that you put the money aside in an account that you control. If your employer can structure it this way you could even use a payroll deduction to fund a savings account. You'll have the money on hand to meet anticipated increases in your mortgage payments but you won't have to deal with the regulations concerning refunds of escrow overpayments.

-- Posted: Jan. 14, 2002