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Escrow account explanation

Escrow account explanation: I wanted to do a video on escrow accounts for property taxes and homeowner’s insurance, and explain this in advance of closing to help clarify things.

Homeowner’s insurance escrow explainer – Escrow account explanation

First, let’s take homeowner’s insurance. As you can see this form is a closing disclosure I’m focused on. This is the second page, under Other cost, category F for Prepaids, category G for the Initial Escrow Payment. Looking at homeowners insurance on this particular closing, they’re taking 12 months under F for Prepaids. And then under G, under O1 they’re taking another three months for 15 months total. That seems excessive. Here’s where that 15 months comes from.

How mortgage payment due dates affect escrow accounts

This particular closing is closing on June 21st, 2023. So their homeowner’s insurance is going to roll over every June 21st. The first payment on the mortgage in this instance won’t be due until August 1st. Why? Because a mortgage is paid in arrears, it’s paid backwards. So the August 1st mortgage payment due date is actually for July. You can see here they’re collecting interest from June 21 to July 1. So August 1 starts the full mortgage payments for July. September 1 for August, and so on. Since you’re not making a full mortgage payment to the new lender until August 1st, by the time June of next year rolls around you will have only made 10 payments. So to pay the second ­year bill from June 21, 2024 to June 21, 2025, you’ll be short two months. You’ll have made 10 payments to the lender, you’ll be short two months. So there’s the three. You’re paying for the first year in advance from June 21, 2023 to June 21, 2024. The three covers two months of the shortage for the next bill, June 21, 2024 to June 21, 2025. However, wait, that’s only 14 months.

There is money collected for a “pad”

Why are we collecting 15? So you’re paying one extra month as a pad or a cushion. Over time your insurance bills would go up as the property value goes up, so they take a small pad up­front at closing. So out of 15 months, 12 months is to pay the first year in advance, 2 months is to pay the shortage to have a complete 12 months on the second ­year installment, and then there’s a 1 ­month pad.

Property taxes escrow explainer – Escrow account explanation

This is the same concept for property taxes. Now, this particular property happens to be in Washington DC. Property taxes are due in Washington DC, in October and then again in March. So if we’re going to closing in June, and you’ve got a first payment due August 1, by the time the next tax bill comes due October of this year, you will have made an August payment, September and then October 1. A six­ month tax bill is due in the district, because in Washington DC the taxes are due bi­annually. If you’ve only paid three months worth, we’ll be short three. And we’re going to be collecting for the next month’s bill and the pad. So same concept.. You can see here they’re collecting nothing under Prepaids, zero months.

Under GO3, they’re collecting six months. So six months in advance goes for the three months we’re going to be short on the October tax bill. It’s a six­ month bill and we will have only collected three. They collect another couple of months towards the next bill. And then they collect a pad.

So I am due a refund at some point?

So you’re always ahead of the curve on your tax and insurance bills. At some point whenever you sell the property, you’re due a refund. Depending on where you are in the tax cycle and the insurance billing cycle, you’ll be due a refund of a certain amount of unused property taxes sitting in escrow and a certain amount of unused homeowners insurance sitting in escrow.

What’s an aggregate adjustment?

The last thing to explain. A lot of people ask, “What’s this aggregate adjustment?” Negative 450. I can tell you the textbook definition is, “An aggregate adjustment is a credit to the buyer for an amount that is in excess of what’s allowed to be collected at closing. This credit simply reduces the amount collected for the escrow account and is a line item on the CD.”

What they’re saying in English is, “If the lender is collecting too much up here, they make a credit down here to bring it in line with what’s legally allowed to be collected.” Now logic would indicate, “why don’t they just collect a little less up here and not debit and then credit?” For whatever reason, for some accounting reason, they collect what they think they need to collect up here. There’s some formula that someone goes through. And then there’s sometimes an aggregate adjustment or a credit to you to even this out, because it goes a little bit overboard. Which in this case, I think might have been for the property taxes.

Conclusion

That’s an explanation of why the amounts collected at closing for escrows for homeowners insurance and property taxes are collected. I hope that makes sense. Please let me know if you have any questions. Contact me to discuss escrows, your local housing market, mortgage rates, or other mortgage questions. Click here to schedule a call or you can email me directly.