An escrow account helps ensure that your property taxes and homeowners insurance payments are made on time. Lenders usually require mortgage escrow accounts when you finance more than 80 percent of your home's value. You'll need to make an initial large deposit to establish the account. The amount you must deposit depends on your lender's reserve requirements and when your next property tax bill is due. The lender instructs the escrow holder on how much to collect, but you can calculate an estimated deposit amount in preparation for closing.
Calculate Your Tax Installments
Find your property tax rate by inquiring with the local tax authority where your home is located, such as the county assessor's office. Tax rates may change from time to time, so find out the latest tax rate if you're refinancing or establishing an account on an existing loan.
Find out your home's value. When you're buying a home, the lender typically uses the sale price as the basis for your annual tax estimate. The lender's appraisal may differ from the sale price, but neither the lender nor the tax authority uses the home's appraisal for tax assessment purposes.
Multiply the tax rate by your home's value. For example, a tax rate of 1.0 percent and a home value of $200,000 yields an annual tax bill of $2,000. Divide the annual bill by 12 to get the monthly tax installment -- about $167.
Calculate Total Monthly Escrow Installments
Locate your annual homeowners insurance premium. Your lender requires you to provide evidence of sufficient coverage. Your insurance agent or mortgage representative can provide your premium amount.
Divide the premium by 12. For example, a premium of $500 requires monthly escrow payments of about $42.
Add the property tax installments to the homeowners insurance installments. The sum represents how much you must pay into the escrow account each month in addition to your mortgage payment. The initial escrow deposit requires several months of these installments.
Calculate the Escrow Deposit
Determine the month your loan is scheduled to close or fund and your first escrow payment due date. Your first escrow payment is due with your next mortgage payment when you're establishing the account for an existing loan. When you're buying or refinancing, your first payment is due on the first day of the month following the month after you close. Mortgages are paid in arrears; therefore, a June closing means that your first payment is due August 1.
Refer to your escrow holder or lender for an escrow schedule. The schedule shows how many months of installments the escrow holder must collect based on your closing month and may vary by locality because of differing tax due dates. For example, a June closing generally requires five months of taxes and insurance, according to Central Escrow, Inc. This means you must deposit at least $835 into the account (5 x $167).
Add a cushion of two months' worth of installments to the deposit amount to get the total initial deposit due. Most lenders require you to maintain a surplus in the account equal to no more than two months of payments, by law. This cushion covers any additional amount your lender may need to pay when the actual tax bill comes in or if you miss a payment.
- You might voluntarily set up an escrow account if you'd rather pay your taxes and insurance in small amounts every month, rather than lump sums annually. Your lender requires an initial deposit to set up the account on an existing loan.
- When establishing escrow for a refinance, reference your most recent tax bill for the tax rate. Don't refer to your most recent tax bill for an amount, however. The tax amount on your previous bill is based on your home's last assessed value, which may differ from your home's value after the refinance.
- Lenders are required to pay interest on escrow accounts in certain states. Refer to your lender for information on interest-bearing escrow accounts.
- Lenders are not required to maintain an escrow cushion. In fact, the Real Estate Settlement and Procedures Act limits the reserve cushion to two months of taxes and insurance.
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