A mortgage escrow account to cover your real estate taxes and homeowners insurance premium can be convenient, but it is also subject to fluctuations. The lender collects funds for an escrow account based on information available at the time of closing on a new account, or on last year's amounts for an existing account. However, the amount you owe for taxes and insurance can change. If this happens, you could have a shortage in your account that you will have to cover.
Escrow is calculated based on the information the lender has. Take taxes, for example. When you apply for a loan, the lender might only have your first and second quarter tax bills, with the third and fourth quarter figures unavailable at the time. If you pay $1,200 per quarter, the lender has to assume that you will continue to pay that amount quarterly until it hears differently. It will estimate your yearly taxes at four times that amount, or $4,800. Insurance works similarly. If you paid a $500 premium in 2013, the lender will assume your 2014 premium will be the same.
At closing, you will make a lump-sum deposit to cover several months of escrow, or, in the case of insurance, your full year premium. For taxes, the lender will collect the amount due for the current quarter plus a two- or three-month cushion in the event it hasn’t collected enough. So if your taxes are $1,200 per quarter, or $300 per month, and the lender collects a two-month cushion, your initial escrow deposit will be $1,800 -- $1,200 for the quarter and $600 as a two-month cushion. It will also collect your yearly insurance premium. If that amount is $500 and the tax escrow is $1,800, your total escrow deposit will be $2,300.
Because the lender works on estimates, there are times when it will not collect enough escrow to cover the taxes or insurance. The lender will end up short if your taxes or insurance premiums go up. When this happens, the lender will go ahead and pay your taxes or insurance bill, but your escrow account will go into the negative. At the end of the year, the lender performs an escrow analysis on its accounts. The analysis will show that you have a shortage in your account, which the lender will require you to pay. You have the option to pay a lump sum or to spread the amount over the next 12 loan payments.
Taxes and insurance premiums can decrease just as easily as they can increase. If this is the case, the lender will see that you have an escrow surplus when it performs its analysis. If you have a surplus, the lender will cut you a check and mail it to the address on file.