At the end of the year, your escrow account -- the account where your mortgage company holds the money to pay for your taxes and homeowners insurance -- can give you a very pleasant or unpleasant surprise. Every year, your bank gets new information on your property taxes and insurance payments. If the cost has gone down, you'll get a nice check in the mail. If the costs have gone up, it's time to adjust your budget.
At the end of 12 months, your bank will perform an escrow analysis. Your escrow account is reviewed and compared to your current bills for taxes and insurance. Since escrow is collected in advance, the lender might not have enough in the account to cover an increased payment. This is known as a “shortage.” On the other hand, if you’re lucky, the payments will go down and the bank will have more money than needed to make the payments. This is known as a “surplus.”
If you have an escrow shortage due to an increase in your taxes or insurance premiums, you are responsible for the difference. The bank will send you a notice stating the amount outstanding. It’ll be your choice how you handle it. You can either pay the entire shortage in one lump sum or you can choose to have the amount spread out over the coming year. This means if your shortage is $400, expect to pay an additional $37.50 each month the following year to make up the shortage. Your payment might increase more as the lender increases the amount going into escrow to pay the next year's taxes and insurance.
If you have too much money in your escrow account, consider yourself lucky. This usually occurs when taxes go down or payments are overestimated. The lender will pay the appropriate amount to the municipality. Whatever is left goes to you. You will receive notice that you have an escrow surplus and will receive a check not long after that. Your mortgage lender might give you the option to leave that money in the escrow account in case there is a shortage next year.
The lender repeats this process every year. It can be difficult to anticipate if your payments will go up or down. To avoid unpleasant surprises, pay attention to correspondence from your insurance company or taxing authority. If you’re aware that your payments will increase, you can pay additional escrow each month when paying your mortgage to avoid a shortage. If you see that your payments will go down, you can contact your bank to try to decrease your monthly escrow payments, but you’re better off leaving them as is. Think of the money as forced savings which should net you a nice check.