Property Taxes and Homeowner’s Insurance
There is a lot more to your monthly mortgage payment than just the interest and the principal on the money you borrowed. One of the biggest surprises for many first-time home buyers is that their mortgage lender pays their property taxes and homeowner’s insurance for them. Here’s how that works.
A typical mortgage payment is made up of the following: principal, interest, taxes, and insurance. This is often referred to as PITI.
The principal is the amount that is deducted from what you owe the lender. The interest is one month of interest on the remaining principal balance. The taxes and insurance are one month of property taxes and one month of homeowner’s insurance.
When you get a mortgage, the lender wants to make sure you have insurance in case something happens to the house and has to be repaired. Instead of just hoping you have insurance, they insist that you have insurance. They do this by collecting the first full year of homeowner’s insurance at the closing. For example, if you close on the house on September 15, 2018, you will pay for insurance at the closing that covers you from September 15, 2018 until September 14, 2019.
The lender also collects one-twelfth of the year’s insurance premium each month, and deposits it into a separate account, known as an escrow account. By doing that, they guarantee that when the next insurance bill is due on September 15, 2019 (a year from the closing date), they will have enough money in the escrow account to pay the bill.
They do the same thing with the property taxes associated with the house by collecting one-twelfth of the annual tax amount each month and depositing that money into the escrow account. When the taxes are due (in February and June in Colorado), there will be enough money in the escrow account to pay the tax bill.
Lenders are allowed to collect 2 months extra of property taxes and homeowner’s insurance. They use these funds as a cushion, in case your taxes or insurance increases. They collect that money at the closing and deposit it into the escrow account.
Depending on the type of loan you get and the size of the down payment you make, you may not be required to have an escrow account. However, lenders will charge you a fee to discourage you from not having an escrow account. Some people are very bad at budgeting and may not save money to pay their property taxes and homeowner’s insurance each year, if they aren’t forced to do it. So lenders make it more expensive for you to avoid an escrow account.
Each year, you will still receive a tax bill and an insurance bill, but the lender will pay the bills for you with the money that’s in your escrow account. The bills are only sent to you so you will have a record of how much your property taxes and homeowner’s insurance are.
If you are required to pay mortgage insurance, the lender will also deposit that money into the escrow account and pay it to the mortgage insurance company each month.
Once a year (usually in January), the lender will send you an escrow analysis, which is a report that shows you how much money you have in your escrow account. If you have too much because your taxes or insurance decreased, they will refund the money to you and lower your mortgage payment for the following year. If your taxes or insurance increased (much more likely than them decreasing), the lender will increase your mortgage payment for the following year.
If you have any questions, feel free to contact us.