Escrow/Settlement Accounts
There are three very different accounts that are all types of escrow account. Each requires money be deposited in a shared account and managed by an escrow officer, but they are used for unrelated purposes, which can be confusing.
How Escrow Accounts are Used:
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Earnest Money Deposit: The check you write as earnest money is deposited into an escrow account as soon as the offer is accepted. The money sits there until closing/settlement, when it is transferred to the seller as part of the purchase.
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Interim Interest Payment: If your closing/settlement date is any day other than the last day of the month, there will be mortgage interest due for the days between the closing date and the first of the next month. (So if your settlement/closing date is the 10th, you owe a partial monthly payment equal to the 20 (or so) days before the 1st day of the next month.)
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Impound Accounts: if your down payment is less than 20% (as in, the loan is for more than 80% of the selling price), lenders can (but don’t always) require you to open an escrow or impound account.
- FHA/VA and other Government-Insured loans require them, as well as most conventional lenders when you borrow more than 80% of the selling price.
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Property Expenses: they pay your:
- Property Taxes
- Hazard Insurance
- Mortgage Insurance (if required)
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Deposit At Closing/Settlement: you will usually be required to deposit cash for:
- Up to 6 months’ payment of Property Taxes
- Up to 2 months of Hazard (Homeowner’s) Insurance
- Up to 2 months of Hazard Mortgage Insurance
- Why Lenders Require Impounds: it is to protect the collateral of the mortgage (the property) against liens (from unpaid taxes) or an uninsured decrease in the property value (from natural disaster damage). By managing the payments of your taxes and insurance, the lender decreases their risk.
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Enforced Savings Account: Each month, part of your monthly payment goes into this account and the funds collect (and in some states, earn interest for the borrower) until they are due to pay your tax or insurance bills.
The lender makes these payments for you, and the payment from escrow will show up on your loan statement (it’s a good idea to check it).
It’s like a savings account in that you contribute a little bit each month so you don’t get hit with a big tax or insurance bill 6 months into owning your new home. - How Much It Costs: it can cost between $100 and $150 to set up an escrow/impound account.
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Annual Adjustments: once a year, the lender will analyze your escrow account to make sure your monthly payments cover the amount paid out.
- Reserves: Generally, the lender tries to make sure you have at least 1 month’s worth of payments as a cushion against shortfalls.
- Shortfalls: If the tax or insurance bill is higher than expected, the lender covers any shortfall for that year, then increases your monthly payment amount to repay the shortfall and make sure next year’s bills will be covered.
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Canceling Impound Accounts: Many (but not all) lenders allow you to cancel your impound account and take responsibility for your own taxes and insurance payments when your equity reaches 80% or 82%.
- Check Your Agreement: It should be in writing whether you can cancel the account at 80% or not. If it isn’t and your loan has been sold, you may not be able to cancel the account as long as you keep the loan.
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Not a Quick Rebate: Don’t count on receiving a check for the amount in your account quickly. This can be a problem if you are counting on that cash for your refinanced loan closing costs.
- Paperwork Delays: It can take months for the paperwork to clear and the money to be sent.
- Prepaid Taxes: If the money has already been sent to the local tax authority, the lender may not be able to get it back to send to you. Tax collectors can refuse to refund it and then credit it towards your next tax bill.
- Check Your Statements: Always review your impound account statements, mistakes do happen, especially during the transfer of accounts when loans are sold.
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