What is an Escrow Account?
To obtain a mortgage loan, you must agree to keep a hazard insurance policy in force to protect the lender’s investment. This insurance is part of your homeowner’s insurance policy. If the house you are purchasing is in a designated flood zone, you will also need to obtain flood insurance. The flood zones are determined by the Federal Emergency Management Agency (FEMA).
You also must agree to pay all real estate taxes when due. These taxes are assessed by the county in which the house is located and can also include city taxes if the house is within city limits.
An escrow account is an account that is set up by your mortgage company to pay future homeowner’s insurance premiums and property taxes on your behalf.
How an escrow account works
If you have an escrow account, when you make your monthly payment on your mortgage, the lender takes a portion of that payment and places it into a separate account (the escrow account) where the money is kept until your real estate taxes or homeowner’s insurance premium come due. They then pay your taxes and insurance from this account on your behalf.
Your monthly payment now consists of a Principle payment (paying back the loan based on your amortization schedule -30 years , 15 years etc.), Interest accrued for that month, 1/12 of the annual Tax bill and 1/12 of the annual Insurance premium. This is referred as you PITI payment.
When you close your loan you will have to “fund “ the escrow account by paying an extra cushion into the escrow account as a precaution to ensure that your lender has enough money to make the payments when they come due. This cushion is normally equal to 3 months of tax and insurance payments and is set by the Real Estate Settlement Procedures Act (RESPA). This is one of the prepaids you will pay at closing.
Do I have to have an escrow account?
Not always. If you make a down payment of 20% or more of the purchase price and have a decision credit score of 680 or better, you can choose to “waive” having an escrow account set up by the lender. This means you are responsible for paying the taxes as well as the renewal premium on your homeowner’s insurance when they becomes due.
Be aware that there is a cost to waiving escrows in the form of a “delivery fee” that the lender must pay to Fannie Mae or Freddie Mac. If the lender has to pay it, you can bet they will pass this along to you in one way or another. That cost is 0.25 discount points (0.25% of the loan amount – $250 on a $100,000 loan) and the lender will build this cost into your rate or you may pay it at closing. So if you qualify and choose to waive escrows, you have to pay for the privilege to do so.
We find that most people prefer having an escrow account. They think of it as a Christmas Club account so they don’t get hit with a large expense for taxes or insurance when due.
How are escrow accounts handled in a refinance transaction?
When refinancing a mortgage, the current escrow account is not transferred to the new mortgage lender. Instead, the amount still available in that account will be returned to you usually within 30 days after your current lender receives their payoff funds from your new lender. That means that you will have to fund a new escrow account through your new lender.
At First Nations Home Mortgage, Inc., we answer questions about escrow accounts every day. Give us a call today!