I had been paying the mortgage on my first home for a year before I truly understood what exactly my escrow payments were used for, embarrassing but true. At the end of the year, I had overpaid on my property taxes because the bank had not accurately charged me throughout the year. It was in this moment I realized I wanted to understand fully what I was paying for so I could audit my monthly payments in advance, instead of reacting to a mistake that had been going on for months.
Mortgage payments are comprised of two categories: payments that are going to your bank and payments that are going to your escrow account.
Payments to the Bank:
First and foremost, a monthly mortgage payment is comprised of principal and interest.
Principal refers to the amount of money originally borrowed. Example: if you purchased a home for $125,000, put 20% down for a down payment ($25,000), your principal would be $100,000.
Interest refers to the interest a lender is charging you to borrow that principal amount of money, this is based off the interest rate secured when originating the loan.
At the beginning of loan repayment, mortgage payments will be mostly interest and over time payments will gradually begin paying down the principal in larger proportion. This is called an amortization schedule. Bankrate has an Amortization Schedule Calculator to help visualize this that I like to use.
Payments to Escrow:
Payments to escrow accounts include insurance and property tax payments. Lenders use an escrow account to make these payments on your behalf.
Property Taxes are paid to your local government based on your property’s assessed value. Through funding your escrow account monthly your lender will make this payment for you.
Home Insurance similar to your tax payment your lender will pay your Home Insurance premium on your behalf if you fund your escrow account to cover your insurance premium.
Private Mortgage Insurance (PMI) If less than 20% down payment is made when securing a loan there will be additional mortgage insurance required. This can be paid via an escrow account by your lender.
Homeowners Association (HOA) Fees can come out of your escrow account as well, but it depends on your lender and the association. Not all lenders or associations will allow payments from an escrow account. These fees are most commonly associated with condos or townhomes but some neighborhoods will also have HOA fees for neighborhood amenities.
Ultimately, your lender is providing you a service through managing multiple different payments for you via an escrow account, so you only need to worry about making one monthly payment to your lender. But as I shared at the beginning of this post, it is still in your favor to know exactly how much your taxes/insurance payments are so you’re not overpaying or underpaying throughout the year. I was fortunate to be overpaying, because I got a nice refund check. Had it been the opposite, I would not have been very happy to write a surprise large check!
You also have the option to opt out of funding an escrow account and instead manage these payments on your own (typically, you will need at least 80% LTV to exercise this option; it will depend on your loan type and financial circumstances).
As always, knowledge is power. Understanding the details of your mortgage payments allows you to make informed decisions and audit your payments for inaccuracies. Questions? Don’t hesitate to reach out!
xx,
Claire
