Pay into the Kitty: How Does Escrow Work?

When you finance your home, it’s very typical to see money set aside into an escrow account. What purpose does an escrow account serve, and do you have to have one?

When I explain escrow or prepaid items to my customers, I always liken it as to setting up a kitty. You know, like in poker. A place where your money sits until it’s decided where it should be paid. And if you’ve ever played poker, you keep adding to the kitty, till it gets passed out; then another kitty is created, and so on and so forth, until someone is broke or mad. Escrow for a mortgage is a very similar situation except hopefully we avoid the mad or broke part (particularly the broke part – that kind of talk makes a lender nervous).

What exactly is escrow? It’s part of your monthly payment that’s held by your mortgage servicer in an account (also known as “impounds” or “reserves”) so that your mortgage servicer can pay your homeowner’s insurance, taxes and, if applicable, mortgage insurance and flood insurance when the time is due. Some mortgage products or lenders require escrow. Sometimes, it’s not required or even allowed. It just depends on what type of loan you are getting.

Typically on a purchase, a lender will collect a 1-2 months portion of whatever your annual premium is for your homeowner’s insurance and put it into escrow. For instance, if your homeowner’s premium is $1000, the lender will ask for $200 in reserves. In addition, the lender will also collect the full $1000 premium to pay for your homeowner’s insurance until the next payment is due, a year from now. For taxes, lenders typically collect 4-5 months of reserves. One reason you always have more taxes collected then homeowner’s insurance is because all city and county entities usually want the tax bill paid in advance from when it is due. For instance, if taxes for 2008 are due in October, where do you get the money for November and December if you don’t collect it at closing? Further, if you had closed your loan in August, and the first payment isn’t due until October, you already had missed out on collecting escrow for 2 months if the borrower doesn’t make his payment until the last minute. You need that kitty to pay everyone when the time is due.

The other portion of escrow that is collected is per diem interest. This escrow portion collected is why most folks try to close on or about the last day of the month. The lender usually requires the borrower to pay the interest that accrues from the date of settlement to the first monthly payment. So, if you close July 28th, your lender will collect three days of “per diem” interest from July 29th to July 31st. Interest is collected in arrears, so your payment that is due September 1st will include the interest for the month of August.

The big thing to know about the prepaid section of a Good Faith Estimate is that you shouldn’t focus too much on this section when comparing lender’s costs. Whatever the lender reflects needs to be collected for escrow may vary a bit from lender to lender, but when you show up at the closing table, it just is what it is. The lender can’t control what the taxes are on the property, when the closing will be or how much you negotiate for homeowner’s insurance. Also, many times you can waive escrow, paying taxes and insurance out of your own pocket when the time is due. This luxury usually costs you a bit more out of your wallet. Think about where a lender would stand if you didn’t pay your tax bill or your mortgage. The tax man gets his money first. No big surprise, there, huh?


Let My Experience Work For You!

Email your home loan financing questions to Kristin Abouelata, Home Loan Specialist with Mortgage Investors Group, at question@kristinmortgage.com or call direct: (865) 567-0113 Toll Free: 1-800-489-8910. For more information visit her website at www.kristinmortgage.com Home Loans Plain Talk.

Your Mortgage: Your Biggest Debt, Your Biggest Tax Deduction

Many people out there are considering buying a home, but are wary to incur what is most likely their largest debt ever. But you should know, that this debt can work to your advantage when the tax man comes knocking…….

It’s almost April 15th, and my husband just bounded down the stairs to announce that he finally finished up what needed to be done to submit our taxes for the year. Some years we make it by the deadline, some years we don’t. We both work on commission, and depending on the how the year went, we’re less excited about this time of year than others. When we actually don’t file an extension, we’re kind of proud of ourselves. It got me to thinking about paying Uncle Sam, and what one advantage we have working in our favor. We are homeowners.

So what’s the big deal about being a homeowner when tax time rolls around? Well, what many people who have never owned a home may not know is that your mortgage is not only your largest debt, but also it can be your largest write off as well. (And honestly, there are probably plenty of homeowners out there whose accountants prepare their taxes for them, and they never really noticed how much this write off counts!).

This time of year, many folks are digging through file folders, nooks and crannies to find charity receipts, business receipts and any other write off they can remember. How does the old saying go? You can’t escape death or taxes. And tax time can make you feel like your facing death anyway. But what some people who’ve never owned a home don’t realize is that you can deduct all the interest from the past year you’ve paid monthly on your mortgage payment from your annual gross income. Yep. You read that correctly. And may I remind you that during the honeymoon phase of your mortgage repayment, the majority of what you pay (unless it’s an interest only loan) goes toward interest, not principal reduction. So think about it: potentially, this tax deduction could pop you into a lower tax bracket if the numbers work out.

In January of every year, your mortgage servicer will send you a statement that reflects the amount of interest you paid, and you can reflect this amount on your 1040 as a deduction (or you can tally up the amount from your checkbook). What’s more, unlike the majority of deductions, you get to count ALL of the interest portion of your payments you made last year. So, buying a home versus renting can make even more sense for you. Not only are you living in a home that will increase in value over time, you also have all that interest to write off in April. Sounds like a win-win situation to me.

Understandably, the tax break is only a side benefit to owning a home. The biggest value is having a place to call your own that you and your family love. But, writing a smaller check come April sure would feel good, too. Don’t you agree? So, if you’ve been considering buying a home, perhaps this bit of knowledge will be the final nudge that makes you move forward. And next year, you can look forward to a new advantage at tax time.
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Let My Experience Work For You!Email your home loan financing questions to Kristin Abouelata, Home Loan Specialist with Mortgage Investors Group, at question@kristinmortgage.com or call direct: (865) 567-0113 Toll Free: 1-800-489-8910. For more information visit her website at www.kristinmortgage.com Home Loans Plain Talk.