Your Lender may require you to pay funds into an escrow account to ensure the timely payment of your real estate taxes, homeowners insurance and/or other items. By law, the Lender is not allowed to retain in your escrow account more than an initial amount based on two month's of the annual billing for each category being collected, i.e. taxes, insurance, etc.
The following steps and example are provided to help you estimate the amount of money you may be required to put into your escrow account:
- Determine your first payment date. This date is generally two months after your closing date. For the example below, we will assume the first payment date is in July.
- List all of the payment amounts for items that will be paid out of your escrow account and the date paid for the next twelve months. In our example, the taxes are paid in December and June and insurance is paid in March. The annual amount of taxes is 3,114.96 and the annual insurance premium is 807.00. The total amount is $3,921.96.
- Divide the total $3,921.96 by 12 monthly payments ($3,921.96 / 12 = $326.83).
- Create a trial running balance for the next 12 months listing all payments to the escrow account and all payments out of the account when the items are paid.
- Increase all the monthly balances to bring the lowest point in the account (May - 980.49) up to 0.
- Add any cushion your lender requires to the monthly balances. The cushion may be a maximum of 1/6 of the total escrow charges or 2 x 326.83 = $653.66. The account should fall to the cushion amount at least once during the year. In our example, it is in June.
- The initial payment is the amount the Lender is allowed to collect at closing to establish the escrow account. It is the sum of your low point plus the cushion amount. In our example the initial payment amount is $1,307.32.
- The aggregate escrow adjustment is the difference between the deposit required under the aggregate accounting and the sum of the deposit required under single-item accounting. We just calculated the deposit of $1,307.32 which is required under aggregate accounting. Looking at our Closing Disclosure, we see the following reserves deposited with the Lender at closing:
Hazard Insurance: 5 months x 67.25 = $336.25
Taxes: 7 months x 259.58 = $1038.32
For a total of $1,374.57 under the single item analysis. Since the Lender cannot collect more than the initial payment, the result is an overpayment, i.e. $1,374.57 minus $1,307.32 = $-67.25 which is the aggregate escrow adjustment.