|Escrow makes payments
-- even on fixed-rate mortgages -- variable
Think of it as insurance for the
Mortgage escrow accounts exist to help borrowers
accumulate money for property taxes and homeowners' policy premiums
a little at a time. Escrow can help avoid financial surprises such
as missed payments to the government, but foul-ups can happen and
borrowers need to keep a close eye on what money is going where.
Not everybody needs to set them up, but home buyers
may benefit from using them. "The lender is going to pay your taxes
for you, and many first-time homeowners, that's the way they prefer
it," says Rick Harper, director of housing for the Consumer
Credit Counseling Service of San Francisco. "They don't want
to get stuck with a huge tax bill."
When people take out long-term, fixed-rate loans,
they may not realize the amount they pay will sometimes fluctuate
from year to year. The culprit that unfixes the fixed loan is the
escrow account. Some people are required to have them -- chiefly
borrowers who put less than 20 percent down and people with government-insured
mortgages such as those backed by the Federal
Housing Administration or Department
of Veterans Affairs.
How escrow operates
Escrow operates somewhat like a savings account, but customers must
make monthly deposits as spelled out in their loan documents. Those
payments accrue at the bank -- with interest in some states -- and
the lender becomes responsible for paying the borrower's property
taxes and insurance premiums. An escrow account usually remains
in place until a borrower pays the mortgage down to the 80 percent
loan-to-value threshold, though people can elect to keep the account
in place for the full loan term.
"The escrow account can be a wonderful tool for people
to be able to effectively budget. Those bills are being paid and
they're obligated to be paid no matter what," says Jan Schamp, escrow
manager for the Norwest
Mortgage arm of San Francisco-based Wells Fargo & Co. "We
have a lot of people who choose to leave that escrow intact."
Going into a loan, it's difficult to know exactly
how much escrow payments for "TI" -- taxes and insurance -- will
increase the overall monthly bill for "PITI," or principal, interest,
taxes and insurance, lenders say. The seller will often volunteer
to show the most recent tax bill, or borrowers can get the information
through the local tax-collection authority, usually an arm of the
"They can check locally to know what's reasonable,"
As taxes and insurance policy bills change, so will
Most lenders run an analysis program each year to see whether the
amount a borrower contributed over the course of the past 12 months
was enough to cover all the tax and insurance bills due during that
period. Customers receive a transcript of the results showing what
was paid out and what was collected.
Lenders typically require that an extra month or two
of payments be maintained in the account as a reserve. But because
tax assessment or rate changes and premium adjustments can happen
any time over the course of 12 months -- and escrow payments remain
constant for a year at a time no matter what -- lenders sometimes
have to cover shortfalls out of their own pocket. They recoup that
money the following year by boosting a person's required monthly
"After the end of the first year, the regular escrow
analysis done by lenders will compare what we initially told them
would happen to what actually happened," says Schamp. "We projected
this much money would go in and this much money would go out. This
is what actually came into the account and this is what actually
While these annual adjustments cause a mild stir in
a homeowner's budget, escrow can occasionally shift dramatically.
With new construction, escrow payments tend to surge after a property's
completion, according to Sandra Munn-Travis, vice president of mortgage
loan servicing for Harris
Bank. The Chicago-based company is a subsidiary of Bank
"What the customer needs to watch out for is the fact
(lenders) are required to calculate escrow based on the last disbursement,"
she says. "If the house is being built from scratch, the (last tax)
bill is only going to be on land. There may be charges of just $800
on that land, so their escrow is going to be very small.
"The next year, depending on when the house is totally
built, they may get one payment that's just land, but the second
payment is improved with the house on it. All of a sudden the taxes
go sky-high and there's such a shortage" in the escrow account,
she adds. The lender will cover that shortage, but it will have
to do things to compensate: increase the base escrow payment the
following year to cover the higher taxes and make up the loss by
dividing it into 12 portions and adding it to each of that following
year's monthly payments.
Watch closely when loans change
Borrowers also should watch their escrow accounts closely when any
loan transfer occurs. A transfer can happen in one of two ways:
when somebody refinances or when a lender sells its loans to another
Legally, the old lender must pay taxes and insurance
up until the loan either closes or leaves its possession. But with
so much paperwork involved, wires do cross. Sometimes, both companies
end up paying the tax bill -- and sometimes neither one does. In
either case, a homeowner's bill can be affected the next time escrow
is adjusted. As long as the homeowner has made the proper payments,
the lender is responsible for any problems created by an unpaid
bill, but straightening it out can take time. Lenders say the best
way to avoid problems is to communicate and make sure all the parties
involved know the game plan. Customers should also keep all records
and review them for errors.
"The customer has to be the proactive one," says Howard
Gosnell, escrow services manager for Mercantile
Bancorporation Inc.'s mortgage division. The bank is based in
In the event of a loan sale, for example, the escrow
account typically will transfer to the new lender along with the
mortgage, according to Norwest's Schamp. A borrower should receive
a statement from the old lender spelling out everything that was
collected for and paid out by the escrow account up until the day
of transfer. He can compare that with the annual escrow analysis
statement sent by the new lender at the end of the year. It should
pick up where the old one ended.
With a refinance, the old lender usually shuts the
escrow account and either reduces the amount it gets at closing
by the balance of the account or refunds the borrower via check.
The company should provide a short-year analysis of activity in
the account up to that point in either case.
Still, a customer can do everything by the book and
run into trouble. That's because large mortgage companies usually
process borrower payments in huge computerized batches.
A nationwide player, for example, may already have
sent an individual's money along to a third-party tax processor
or the taxing agency itself ahead of the actual tax due date. If
a borrower closes his loan out with the old lender -- and the new
lender pays the bill on its actual due date with the new escrow
account -- he may end up waiting months to get a refund from the
old lender. Some tax authorities may refuse a refund altogether
and consider one of those payments a prepayment toward the following
"The borrower anticipates he's going to get the money
back from us but that money may already have been sent to the tax
company," Gosnell says. "Or there are even cases where the taxes
may already have been paid.
"It causes real problems, especially in situations
where you have a refi boom like 1998 when a lot of those refis occur
within the same time frame."
People should therefore not count on using an escrow
tax rebate to cover the new loan's closing costs.