Honest Mortgage Answers

Escrow Account Confusion

One of the most difficult things for borrowers to understand is the way an escrow account works for them. I always make it a point to explain escrow account information to all of my clients (unless they prefer not to know about it) so I thought I would post about it here as well. An escrow account is an account in which the lender holds a borrower's money in a non interest bearing account for future property tax and homeowners insurance bills. Okay, that is easy enough to understand but how do they calculate how much to hold at closing and why is it so much??? I will try to make this as easy to understand as possible.

All Michigan real estate owners have 2 property tax bills due every year. For the most part, these bills are due on July 1st and December 1st. Let's say the closing on your new home takes place on March 30th. Your first mortgage payment is not due until May 1st. With every principal & interest mortgage payment you make, you also send 1/12th of your July Tax Bill and 1/12th of your December Tax Bill (Tax Bill divided by 12 = 1/12 of the tax bill). By the time July 1st comes around, the lender would have collected 3 months of mortgage payments and 3/12ths of your Summer Tax bill, right? Right. You are 9/12ths short on your Tax Bill. Well, this 9/12ths of your Tax Bill will be collected at your closing on March 30th by the bank/investor and they will most likely add another 2/12ths for a cushion in case your Tax Bill increases in July. Understand? I hope so.

It works the same way for your December Tax Bill. If your closing was on March 30th and your first payment is due on May 1st, how many payments will you have made by December 1st? The correct answer is 9. Your lender has collected 9/12ths of your Winter Tax Bill. You are 3/12ths short, right? Nope, your lender collected 3/12ths at closing and an additional 2/12ths as a cushion in case your tax bill increases. This will work the same way for your homeowner's insurance premium that is due each year.

In addition the above math, there are Federal Regulations that dictate exactly how much a lender can hold in your escrow account. If the above math equals an amount over the Federal limit, you will receive that money back at closing in the form of an aggregate adjustment.

Well, some of you may have tax bills that are due on different dates. If that is the case, the math is still the same. Take each tax bill and divide by 12. Count the number of payments made before each tax bill is due. Subtract that number from 12 and you have the total number of monthly tax payments (?/12) that will be collected at closing (you may want to add 2 months to that figure for a cushion so you are not caught off guard when the lender does).

I hope you find this information helpful come closing time. As always, if you have a mortgage or real estate related question or if you would like to do business with Alex Toth, the Michigan Loan Officer, please feel free to call me at 877-300-9378 or email me anytime.

Posted by Jason Lash at 11:34 AM