An escrow account contains funds held
by a lender for future payment of property taxes and applicable insurance, such
as homeowner/hazard insurance, flood insurance, and/or mortgage insurance
Private Mortgage Insurance. Lenders utilize escrow accounts to ensure
that the loan collateral is protected from losses resulting from tax sales for
unpaid taxes or lack of insurance coverage due to unpaid premiums.
At closing, taxes for the current year
are pro-rated, and the buyer pays up-front for a homeowners insurance policy
for one year. The closing attorney or settlement agent establishes the escrow
account on behalf of the lender to pay future tax bills and insurance renewals.
The lender does not pay interest on
the funds held in escrow, and the lender does not charge a fee to manage the
account. Lenders analyze the escrow account annually to prevent holding too
much money, and the amount a borrower pays into the account each month can
change to avoid accumulating overages or shortages.
The lender will generally calculate
the tax escrow based on the tax bill used for prorations at closing. Sometimes,
however, the tax assessment used for proration purposes is obviously much lower
than future tax assessments will be - for example, cases where prorated taxes
were based on unimproved property, or prorated taxes were calculated with
exemptions no longer applicable for the new buyer. In such cases, the closing
agent will calculate an estimated future tax bill based on formulas set forth
by the taxing authority. The estimated future tax amount is then used to
establish the escrow account.
Insurance escrows are based upon the
known guaranteed renewal premium. If a renewal premium is not known or
guaranteed, the escrows will be based on the annual premiums for the current
At closing, the settlement agent
makes an initial deposit into the escrow account to set it up. The borrower
then continues to make ongoing monthly deposits into the account with each
monthly mortgage payment. When taxes or insurance renewal premiums become due,
the account will pay out these items, and a cushion remains in the account