Many lenders require a tax escrow, an amount paid with your monthly loan payments into an account for the lender to pay your property taxes, as a condition of your loan to avoid the complicated consequences of not paying those taxes. The initial escrow is deposited at the loan closing and since it's your money, not part of your loan repayment, it's also the right time to understand and start tracking how your lender collects and applies those escrow payments.
The Initial Escrow Amount
Your escrow account will be created at closing with an amount to pay property taxes and insurance that accrue between the closing and your first monthly escrow deposit. Your lender determines the monthly escrow deposit amount each year based on your estimated property taxes and homeowners' insurance premiums for the next 12 months, in some cases with an additional escrow for other premiums that are paid less frequently than every year. Lenders may also calculate a "cushion" or "reserve" as part of your escrow payments should there be changes in either taxes or premiums, although many states don't allow or limit reserves.
Escrows and Refinanced Loans
Escrows from your previous loan can be applied to the refinanced loan's escrow requirement or returned to you in a check. To avoid confusion and missed tax payments, be clear on which of these applies to your loan and that your previous lender gives you a "short-year" statement indicating the escrow payments they collected and applied. If your new lender changes your escrow amount or how it is calculated, it must state these changes to you in writing within 60 days of closing.
Your Lenders' Escrow Obligations
The U.S. Real Estate Settlement Procedures Act makes your lender responsible for paying your homeowners' insurance premiums and property taxes as long as you're current with your escrow deposit amount. The act also requires your lender to give you an initial escrow account statement within 45 days of closing, as well as an annual statement that documents your payments, any shortages or projected changes. Your lender must return to you any unused escrow deposits over $50.
Changes in Your Escrow Amount After Closing
Although escrow payments only change with your property tax or homeowners' insurance premiums, these changes can be significant if a homeowners' insurance claim makes your premiums spike or your new home's tax rate jumps from the lower rate for empty lot to the higher rate for a finished lot.
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