Lenders often use escrow accounts to set aside funds for property tax, insurance and other home-related payments. In these arrangements, a set amount is added to each month's mortgage payment so that it can be diverted into the escrow account. The lender then handles relevant bills, paying them directly from the escrow account. If you are a borrower and you pay a surplus of funds into the escrow account, the lender either holds those funds for future payments or returns them to you.
Lenders prefer to maintain cushions in escrow accounts, keeping more money available than is necessary for current bills. The purpose of a cushion is so that the lender can keep making tax and insurance payments from the escrow account even if you fall behind on mortgage payments. The Real Estate Settlement Procedures Act places restrictions on how large that cushion can be. According to the regulations, the cushion in an escrow account maintained by a lender may not exceed one-sixth of the total bills that the account will pay. This is equal to about two months of escrow payments, according to the U.S. Department of Housing and Urban Development.
Once each year, lenders provide you with an escrow analysis, which shows the balance of the funds that are available in escrow and weighs whether the total is appropriate. If the balance in an escrow account exceeds the maximum amount allowed, then federal law addresses how the surplus can be distributed. For a surplus of greater than $50, the lender must return the excess funds to you rather than keep the money in the escrow account. However, the lender can give you the option of using the refund to pay principal or to be credited for upcoming escrow payments.
If the escrow analysis reveals a surplus of less than $50, the lender has some flexibility in how to manage the funds, according to federal law. The lender has the choice of either returning the surplus to you or keeping the funds in the escrow account and reserving it for future tax and insurance payments. If the lender chooses to keep the funds in the escrow account, the funds will lower your monthly escrow payment. Ultimately, you will still benefit from the surplus, even if you do not get to decide how to spend the money.
Shortages and Deficiencies
Federal regulations dictate how lenders manage shortages or deficiencies in escrow accounts. A shortage means there is a positive balance in an escrow account but it falls below the lender's required balance, while a deficiency means that there is a negative balance in the account. In either case, the lender may choose to do nothing about low funds. In the event of a shortage, the lender also may increase monthly escrow payments to make up the difference. Or, if the shortage is less than a monthly payment, the lender may charge the amount directly to you. In case of a deficiency, however, the lender may require you to make up the difference with a single payment or with multiple payments spread over multiple months.