If your mortgage lender pays your property taxes and homeowner insurance on your behalf, you might one day face an escrow spread. This happens when your lender underestimates the amount you need to pay in a given year to cover your taxes and insurance. Your lender will make up the resulting shortage in your escrow account by charging you a higher escrow amount in the next year. These extra escrow payments are spread out through the next 12 months, which is known as an escrow spread.
How Escrow Works
Many lenders won't release mortgage dollars to borrowers unless those borrowers first agree to open an escrow account. In an escrow arrangement, borrowers pay extra with each monthly payment. Lenders funnel these extra dollars into an escrow account. When property taxes and homeowners insurance are due, the lender uses the funds in this account to make the payments on behalf of the borrowers. Under such an arrangement, homeowners don't have to worry about missing their important payments or failing to save enough money to cover these often large bills.
Property taxes and insurance bills can rise and fall each year. If a community needs to build a new high school, it might raise property taxes to help pay for it. If homeowners install a second-floor addition to their residence, their homeowners-insurance premium might jump. If property taxes and insurance jump too high, lenders might fail to collect enough escrow money throughout the year to cover these bills.
Lenders will still pay the property taxes and insurance of their borrowers even if their escrow accounts don't hold enough money to cover these bills. Lenders will make up this shortfall in the following year. They'll do this by hiking the escrow payments during the next 12 months. This 12-month payback period is known as the escrow spread; the shortfall is spread out over a year.
Lenders will still have to use a bit of guesswork to determine the following year's escrow payment after a shortfall. As an example, if a lender estimated that a borrower would pay $6,000 in insurance and taxes in a given year, but those bills actually came in at $7,000, the escrow account in question would have a shortfall of $1,000. The lenders likely would assume the taxes and insurance would be $7,000 going forward. This would come out to a monthly payment of about $583 a month. To make up the $1,000 shortfall, lenders would charge about an additional $83 a month for the next year. That would leave borrowers with a new monthly escrow payment of about $666 before being re-evaluated at the end of the year.
Don Rafner has been writing professionally since 1992, with work published in "The Washington Post," "Chicago Tribune," "Phoenix Magazine" and several trade magazines. He is also the managing editor of "Midwest Real Estate News." He specializes in writing about mortgage lending, personal finance, business and real-estate topics. He holds a Bachelor of Arts in journalism from the University of Illinois.