Escrow can be one of the more confusing parts about your home loan. As you’re researching mortgage options, you may come up with more questions than answers on the topic, such as:
- What is an escrow account?
- Why are they sometimes required by mortgage lenders as a part of a loan agreement?
- What’s a minimum required balance?
The experts at Mr. Cooper say it’s helpful to think of an escrow account like a piggy bank: Every month, a portion of your mortgage payment is deposited into it. And then, when your homeowner’s insurance and property taxes come due, your mortgage company uses the money in your escrow account “piggy bank” to make those payments.
When are borrowers required to have an escrow account?
It all depends on your loan and your lender. According to the government’s Consumer Financial Protection Bureau, “many lenders require that you pay your taxes and insurance using escrow, so they can make sure that the bill gets paid.” In addition, the CFPB adds, escrow accounts can sometimes be required by law.
If the loan you’re considering requires an escrow account, this requirement will be clearly stated in the documents you review and sign during the closing of your home loan. An escrow account requirement is a good question to ask of potential lenders up front.
How is your lender escrow account used?
If you’re a homeowner, you’re responsible for certain bills each year, like insurance and property taxes. The escrow account, according to the CFPB, “helps you pay these expenses because you send money through your lender or servicer, every month, instead of having to pay a big bill once or twice a year.”
An escrow account ensures that you always have money to make these important payments, no matter your situation at the moment the bill comes due. Not paying your taxes or insurance can have expensive consequences, the CFPB notes, and escrow accounts can help homeowners stay on top of things. (Federal law requires your lender to make the payments for any escrowed items on time if they administer the account for you.)
What’s a minimum required balance?
As with any account, having a little bit of a “cushion” in your escrow account won’t hurt — and in many cases, your lender will require it. But don’t worry; state and federal laws, along with your loan agreement, place limits on just how much cushion lenders can require you to have in an escrow account. It’s typically twice your monthly escrow contribution — per the federal Real Estate Settlement Procedures Act (RESPA). For example, if you’re required to put $500 a month into escrow, your minimum required balance would typically be $1,000. The CFPB notes that this gives you a two-month cushion.
We know that escrow can be complicated, but Mr. Cooper is here to help. Click here to learn more about escrow (in plain English).