Escrow Accounts in Real Estate Transactions

Posted on 1月 23, 2008 by Nancy Liu | Category: Real Estate

When a buyer purchases a property with a mortgage, the mortgage lender often requires the borrower to set up an escrow account with the lender.  The purpose of an escrow account is to ensure that the borrower will pay the property’s property taxes and insurance premiums (hazardous insurance, or flood insurance, if any) on time.  This would in return reduce the risks of the property’s being foreclosed due to delinquent property-tax payments or the risk of total loss of the property when fire or flood occurs  and there is no insurance coverage.  Both risks would damage the lender’s collateral on the loan, the property, and cause the lender to suffer economic loss.  When the property tax or insurance is due for payment, the lender will make those payments out of the borrower’s escrow account, and the borrower will no longer be required to pay them out of his own pocket at that time.  Therefore, the only disadvantage to the borrower by setting up an escrow account is the loss of interest on the money deposited with the lender before  those bills are due.  The advantage of setting up an escrow account is that the borrower does not have to remember the due dates of property-tax and insurance payments .This would reduce the borrower’s risk of losing the property, too.

If an escrow account is set up in connection with the loan, the lender will reserve a certain amount of money in the account at closing.  Later on, every month during the term of the loan, the borrower will also be required to deposit into the account an amount equal to the collective sum of one/twelfth of the total property tax and insurance; this amount will be included in the borrower’s monthly mortgage payment.  A portion of the monthly mortgage payment is to pay the interest and principal on the loan, and a portion is to be deposited in the escrow account for the payment of the property tax and insurance.  The lender also keeps a cushion amount in the escrow account, so in case the borrower defaults on the mortgage payment or there is an increase in the property tax or insurance premium, the lender will still have enough money to make those payments.  The Real Estate Settlement Procedures Act (RESPA) limits the cushion balance of escrow accounts to not more than two months’ payments, which means the lender cannot hold in aggregate more than fourteen months of the borrower’s property tax and insurance payments in his escrow account.

At closing or within forty-five days after closing, the lender must provide the borrower an Initial Escrow Account Statement. This statement shows the itemized amount that will be collected each month in the upcoming year and how the funds will be used. Usually, each year, the lender will provide a copy of the Escrow Account Statement regarding the disposal of funds in the account for the immediately past year, and the adjustments for the next year if there is a surplus or shortage of  funds in the account.

At closing, the escrow account information is usually shown in the 1000 Section of the settlement statement (HUD-1), and the Aggregate Account Adjustment is usually a negative value at line 1008 to make sure the lender does not hold excess funds in the escrow account.  However, it could be a positive number if the projected payments in the next twelve months are insufficient when the bills are due.  What is the Aggregate Account Adjustment?  Aggregate Account Adjustment makes sure the borrower’s  Escrow Account maintains the necessary balance throughout the year, particularly when taxes and insurance are paid.  When the adjustment value shown on the HUD-1 line 1008 is a negative figure, it means the lender credits the adjustment back to the borrower.

If the borrower  prefers to pay the property tax and insurance himself, and chooses not to set up an escrow account with the lender, the lender will normally charge an Escrow Waiver Fee at closing.

This article is only for your reference. Please do not apply mechanically to any exact cases. You are welcome to consult our attorneys at Liu & Associates, P.C. For contact information, please click here.