Many people find Escrows to be a confusing concept, so here is an explanation that we hope helps. Some key points to start with:
- Your home must be insured effective on your closing date.
- Your insurance bill and your tax bill will come due every year.
- Your escrow account is designed to accumulate funds so your lender can pay these bills on your behalf.
- Your lender is allowed a 2 month cushion, but not more than that.
An Initial Escrow Account Disclosure Statement will be provided at closing, and your lender will send you a new one each year. This disclosure will show the flow of funds into and out of your escrow account. If the analysis determines they are escrowing too much, they are required to refund that overage to you.
At closing you will pay for the entire 1st year’s Homeowner’s Insurance Premium. The premium will need to be paid again anniversary of the purchase date, so the escrow account must be set up to accumulate funds to pay the renewal premium next year by the anniversary date of your purchase closing. With a June closing, you won’t make your 1st mortgage payment until August, and so next June, you will only have made 10 payments, so the escrow account will be short needed funds. This is addressed with the funds you put into the escrow account at closing.
Property Tax Bills in North Carolina come out in July or August, with a September 1 due date. However, tax bills can be paid as late as January 1st. There is no discount for paying the bill early. In most cases we project the tax bill will be paid in December.
In the example below, the insurance premium is $1646.04 and the property tax bill is $3483. These total $5129.04 and 1/12th is $427.42, and that amount is collected with each monthly payment and added to the Escrow Account Balance.
Lenders are allowed to accumulate a 2 month cushion to account for bills going up, etc. And so lenders make a calculation based on the inflow and outflow to determine an Initial Deposit needed at closing to prefund the escrow account with enough funds that at the lowest balance of the year, the escrow account still has a 2 month cushion.
You can see below that at closing a $2200.74 deposit was made into the escrow account. The lowest balance in he escrow account is after the tax bill is paid…which is $854.84 – which is exactly 2 x $427.42 = the required 2 month cushion.
Lenders are required to send you an updated Escrow Account Analysis once a year, and if the lowest account balance exceeds the allowed 2 month cushion, lenders are required to refund the overage to you.
Unfortunately, tax and insurance bills tend to go up, and so the Escrow Account Analysis you receive is likely to show that the Escrow Account is a little short, and so your lender will give you some options to bring the balance back to the required amount.