The winter holidays usher in the most hectic time of the year. Office parties, gift exchanges, and shared meals with friends and family can mean we push aside important end of the year personal finance matters. However, the end of the year is the ideal time to conduct an audit of your finances. This means understanding what you need to do with your escrow account.
The Advantages of an Escrow Account
The most significant advantage of an escrow account is that it protects your financial assets during a real estate transaction, such as when you buy a home. An escrow account eliminates the need to plan for the paying of taxes and insurance premiums. The money that is set aside in an escrow account to pay taxes and insurance premiums automatically comes out of the account before the due dates. You do not have to keep track of the due dates because your mortgage service company ensures every bill is sent out on time. Your mortgage service company should also cover you when your escrow account does not have enough money to pay the tax and insurance bills.
What Happens to an Escrow Account at the End of the Year?
At the end of each year, the bank that handled your mortgage completes an escrow analysis. A representative from the bank reviews the balance of the account and then compares that with your current tax and insurance bills. Sometimes, an escrow account falls short of covering every tax and insurance bill. On the other hand, the amount of each payment might go down, which leaves you with an escrow account surplus.
By December 31 of each year, your bank handles the procedure for either funding a shortage or paying out a surplus. Then, you and the bank reset the escrow account to handle the tax and insurance bills for the upcoming year.
Handling a Shortage
A shortage in an escrow account happens because of an increase in the taxes and/or insurance premiums. Your bank mails you a notice explaining the shortage and the process for making up the deficit. Most banks typically take the amount of the shortage and divide it by 12 for payments at the end of every month of the upcoming year. For example, if your escrow account falls short by $300, you can expect to pay an additional $25 at the end of each of the next 12 months.
Handling a Surplus
When taxes decline and/or your insurer overestimates monthly premiums, you have the good fortune of having a surplus in your escrow account. Your bank pays what the local government should receive in taxes and what you owe in insurance premiums. The remaining surplus goes to you in the form of a check written by a representative from your bank. Along with the check, the bank sends you a notice explaining why your escrow account produced a surplus for the year. Your bank might allow you to leave a portion or all of the surplus in the escrow account for paying taxes and insurance premiums for the following year.
Making Future Adjustments
Your bank repeats the escrow analysis process at the end of each year. You might find it difficult to predict whether your taxes and/or insurance premiums will increase, decrease, or remain the same. To prevent any unpleasant financial surprises, read the information sent to you by your insurance company and the local taxing authority. If you anticipate an increase in taxes and/or insurance premiums, you can deposit more money in your escrow account to cover the additional costs. You should contact the bank to determine whether you can lower your monthly escrow payments if you believe your tax and insurance premium payments will go down.
An escrow account represents a convenient way to stay ahead of the payments curve. Just make sure to monitor your taxes and insurance premiums to cover cost increases, as well as benefit from lower monthly payments.