Isn't That Rich Podcast

How Escrow Payments Are Calculated

When you first set up escrow, the bank calculates your monthly payment based on:

1. Last Year’s Taxes: Or an estimate if you’re building a home or buying new construction.
2. Your Insurance Premium: Provided upfront during your mortgage closing.

Here’s the kicker: Escrow accounts also include a cushion (up to two months’ worth of payments) to cover any unexpected increases. Banks aren’t just guessing—they’re following federal regulations to ensure they’re collecting the right amount.

What’s an Escrow Analysis?

An escrow analysis is an annual review of your escrow account conducted by the bank. This process ensures that the funds in your account are sufficient to cover your property taxes and insurance premiums for the upcoming year, while also adhering to federal regulations on how much the bank can legally hold. It’s a balancing act to ensure you’re not underpaying or overpaying.

Here’s what happens step-by-step during the escrow analysis:

1. Looking Back: The bank reviews all the deposits (your monthly payments) and disbursements (payments made on your behalf) from the previous year. This helps determine how much money was actually needed to cover your taxes and insurance.

2. Looking Forward: Based on this review, the bank estimates your expenses for the upcoming year. This estimate includes any anticipated increases in taxes or insurance.

3. Adjusting Your Payment: If there’s a shortage (not enough money in the account) or overage (too much money in the account), your monthly escrow payment is adjusted accordingly.

Why Do Payments Change After an Escrow Analysis?

Your escrow payment changes because taxes and insurance costs are rarely static. For instance:

• Property Taxes: Local governments may reassess property values, leading to higher (or occasionally lower) tax bills.
• Insurance Premiums: Rising costs for home insurance, especially in areas prone to severe weather, can significantly impact your escrow payment.

The escrow analysis ensures your monthly payment reflects these changes while maintaining a legal cushion (up to two months’ worth of payments) to account for unexpected increases.

What Happens If There’s a Shortage?

If your escrow account doesn’t have enough funds to cover your expenses and maintain the required cushion, the bank offers two options:

1. Lump Sum Payment: You can pay the shortage in full upfront, which keeps your monthly payments stable.
2. Spread Over 12 Months: The bank can divide the shortage amount across your next 12 payments, slightly increasing your monthly payment.

For example, if you’re short by $600, your monthly payment could increase by $50 for the next year to make up the difference.

What Happens If There’s an Overage?

If your escrow account has more money than allowed by federal law (the two-month cushion plus $50), the bank must refund the excess to you. After the analysis, you’ll receive a check in the mail for the overage amount, often a pleasant surprise!

Why Is an Escrow Analysis So Important?

Beyond ensuring your account balances correctly, an escrow analysis is legally required to protect you, the homeowner. Here’s why it matters:

• Accuracy: It ensures your payments are based on actual costs, not estimates from previous years.
• Compliance: Federal regulations mandate that banks only hold a specific amount in escrow, protecting you from unnecessary over-collection.
• Transparency: The analysis provides a clear breakdown of your payments, disbursements, and account balance, so you always know where your money is going.

What Should Homeowners Look For?

When you receive your escrow analysis statement (typically in December for most loans), here’s what to pay attention to:

1. Payment Changes: Is your monthly payment increasing or decreasing? Check the new payment amount and make sure it fits within your budget.
   Important Reminder: If you have automatic payments set up for your mortgage, you’ll need to update the payment amount after receiving your escrow analysis. Failing to adjust it could result in underpayment, and you’ll likely receive a notice stating your payment was insufficient. Avoid the hassle by updating your auto-pay settings right away!
2. Breakdown of Expenses: Review the itemized list of disbursements to see how much was paid for taxes, insurance, and other expenses.
3. Shortages or Overages: Look for any adjustments to your account balance and decide how you’ll handle a shortage if one exists.
4. Cushion Amount: Ensure the cushion aligns with federal regulations—no more than two months’ worth of payments.

If you have questions about your analysis or notice discrepancies, don’t hesitate to contact your loan officer or bank.

Pro Tip: Read Your Escrow Statement Back to Front

Crystal shares that escrow analysis statements often make more sense when you read them from the back page to the front. Why? The back pages show the detailed breakdown of payments and disbursements, giving you the "why" behind the changes. By the time you reach the front, you’ll understand how the new payment amount was calculated.

Common Customer Concerns

Let’s dive into the questions that homeowners often have about escrow and the answers you need to know:

1. Why Did My Payment Increase When My Taxes Only Went Up a Little?

This is one of the most common questions banks hear. When your taxes or insurance increase, your escrow account must adjust to cover those new amounts. But here’s the twist: the bank also needs to maintain that two-month cushion in your account. If your escrow account is short, the bank recalculates your payment to cover both the shortfall and the increased costs moving forward.

Crystal notes, “Even if your taxes only go up $100, your payment might increase significantly to make up for the shortfall while rebuilding your cushion balance.”

2. What Happens to Escrow When I Pay Off My Mortgage?

Paying off your mortgage is a cause for celebration, but it also raises questions about your escrow account. Here’s what happens:

• Remaining Funds: Any leftover money in your escrow account is applied to your final mortgage payoff. For example, if your payoff amount is $50,000 and you have $2,000 in your escrow account, you’ll only need to pay $48,000.
• Option for Refund: If you’d rather receive the escrow funds as a check, you can request it—but your payoff amount will then include the full $50,000.
• Taxes and Insurance: Once your mortgage is paid off, you’re responsible for paying property taxes and insurance directly. This is where self-escrowing (setting up a savings account for these expenses) can be helpful.

3. Can I See My Escrow Balance Online?

Not all banks display escrow balances in online banking systems, but you can always request a detailed statement. This statement shows every deposit, disbursement, and your current balance. It’s especially handy if you’re trying to reconcile your escrow analysis or need to plan for future payments.

4. Why Does the Bank Keep Part of My Escrow Money?

This is one of the most common questions homeowners have about escrow accounts. After all, it’s your money—so why does the bank get to keep a portion of it? The answer lies in federal regulations designed to protect both you and the bank.

1. The Cushion Requirement

Federal law allows banks to hold a cushion in your escrow account, which acts as a safety net to ensure there’s enough money to cover unexpected increases in your property taxes or insurance premiums. By law, this cushion cannot exceed two months’ worth of escrow payments.

For example, if your monthly escrow payment is $400, the maximum cushion the bank can keep is $800. This cushion ensures there’s no shortfall if your taxes or insurance suddenly go up or if a payment is due before you’ve made enough monthly contributions.

2. Why the Cushion Is Important

Without this cushion, even a small, unexpected increase in your taxes or insurance could result in your escrow account being short. That would mean the bank couldn’t pay your bills on time, potentially causing you to fall behind on these critical payments. The cushion helps prevent this from happening and ensures payments are made on schedule.

3. The Bank Is Required to Return Excess Funds

Banks are heavily regulated when it comes to managing escrow accounts. If your escrow account ever exceeds the allowable cushion by more than $50 at the time of your annual escrow analysis, the bank is required to return the overage to you. You’ll typically receive a refund check for the extra amount, ensuring the bank isn’t holding more of your money than necessary.

4. What Happens if There’s a Shortage?

If your escrow account is underfunded—meaning there isn’t enough money to cover your expenses and maintain the required cushion—the bank will notify you of the shortage. You’ll then have the option to:

• • Pay the shortage in full as a lump sum.
  • Spread the shortage across your next 12 monthly payments, increasing your escrow portion slightly each month.

The bank doesn’t profit from the money in your escrow account. It simply holds the funds to ensure that your taxes and insurance are paid on time, and the cushion is there to protect both you and the bank from unexpected changes.

5. Why Don’t Escrow Accounts Earn Interest?

You might wonder, If the bank is holding my money, why don’t I earn interest on it? By regulation, escrow accounts are typically non-interest-bearing, as they’re considered a service the bank provides for your convenience. If earning interest on these funds is important to you, you could consider managing your taxes and insurance payments yourself. However, this requires discipline and careful budgeting to ensure the bills are paid when due.

Crystal recommends choosing the option that works best for your financial situation and encourages customers to talk to their loan officers for guidance.

The Bottom Line

Escrow might seem like just another line item on your mortgage statement, but it plays a crucial role in making homeownership less stressful. Whether you love the convenience or begrudgingly accept it as part of adulting, understanding how it works can save you time, money, and headaches.

Want to learn more? Check out the full podcast episode for an even deeper dive into the world of escrow, complete with laughs and relatable moments. And as always, feel free to reach out to Farmers State Bank with any questions about your escrow account—we’re here to help!