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An attempt at explaining escrow shortages

Well, it's that time of year in Texas when the tax bills are now published and considered due and payable. That being said, I wanted to attempt a quick review of escrow account shortages and how it all works. Get ready to read slowly because this stuff can be really confusing. Just keep this in mind: in Texas, property tax values are based on the owner of the property and estimated value of the site as determined by the County Appraisal District as of Jan 1st.

Tax bills are available for the CURRENT year in OCTOBER and due by DECEMBER 31st.

In March, last year's bill is available. In August, last year's bill is available. In October, CURRENT year's bill is available. So on and so on.

You establish an escrow account which allows your mortgage company to pay out taxes and insurance annually when due. You pay your monthly taxes and insurance in your monthly mortgage payment every month. Sounds easy right? Feb or March rolls around and you get a letter from your mortgage company saying your monthly mortgage payment is going way up due to an escrow shortage. Not so cool? So what could cause this? More than likely it has to do with your property taxes. The amount of your property taxes at the time your escrow account was established vs. your actual taxes now.

Example of new construction closing

Let's use the following scenario of purchasing a new construction home in Texas closing in August 2015. When you close on your new construction, the taxes will more than likely be taxes on land only as the house (improvement) was not complete as of Jan 2014. For simplicity sake we will say the land only taxes for the property are $500/year. You are buying the home for $400,000. Now let's estimate your taxes at $400,000 x going tax rate and again, to be simple, let's say that comes out to $10,000/yr. Big difference. You go to close the loan and your lender has a few choices on establishing the escrow account:

1. Collect actual taxes for escrow account and monthly payment. $500/yr (Lower initial monthly payment but BIG escrow shortage later down the road)

2. Collect ACTUAL taxes at closing for escrow account and ESTIMATED improved taxes for your monthly payment.

3. Collect ESTIMATED improved for escrow account AND monthly payment. $10,000/yr (Too much in escrow account initally which you will not get refunded for months down the road)

Each of the options have their own pros and cons but how the lender decides to close your loan and what your servicing mortgage company allows are two different things. Escrow accounts are regulated by CFPB / TILA (Reg Z) and a mortgage company cannot hold just ANY amount of money in the escrow account. The lender will establish the escrow account with a sufficient amount to cover taxes and insurance when they come due plus a two month cushion. Here's the link for some real fun reading! http://www.consumerfinance.gov/policy-compliance/rulemaking/final-rules/escrow-requirements-under-truth-lending-act-regulation-z/

Since 1976 the RESPA statute has allowed lenders to maintain a cushion equal to one-sixth of the total amount of items paid out of the account, or approximately two months of escrow payments. Typically you will see tax rates (as well as insurance premiums) increase year to year. This allowed cushion enables the mortgage company to have enough money in the escrow account to cover those normal year to year increases and to not cause your escrow account to have a large deficit.

To me, the problem comes down to how the mortgage company can document and justify the amount they are holding in escrow. Keep in mind if they get audited by the CFPB, they better have supporting documentation as to how they determined your annual tax and insurance amounts. If you have a tax certificate from the County that says your property taxes are $500/yr how can they base their escrow figures off of a $10,000/yr estimate?? I am not sure that they can. I can tell you that most mortgage companies will not risk it and do not allow the estimated, higher funds to be held.

If you closed your loan as either #2 or #3 from above then chances are you will be getting a check back after a couple of months of closing and your monthly mortgage payment will get reduced (throwing you into option #1 from above= big escrow deficit when the REAL tax bill comes out). I advise people when they get that check back to hold the money in a savings account and call me in October! They are usually happy they did because they get hit with a mortgage payment increase that can be pretty significant! It's not uncommon to see a mortgage payment increase of $1000/mo when dealing with homes around the $400,000 + price range!

Other potential tax hiccups for a buyer

This same type of situation can happen to buyers when there are certain "big" exemptions on the file of which the new owner will not qualify for. Some examples might be a current Over 65 exemption, Disabled Vet, Ag, etc.

Be proactive

As a buyer, here are some red flags you need to check out when you look at the tax bill on the day you close

* What is the home is currently valued vs. your purchase price. Properties tend to get reassessed when ownership changes. Seems like a trigger with the County Appraisal Districts.

* What are the current exemptions on the property? Is the seller Over 65 and will be removing their exemption?

* When shopping check out the taxing entities and total tax rate. Some areas have additional taxing entities which could cause tax rate to be higher than a comparable home.

Your specific County Appraisal District's website will have more detail on how the values are determined and any other FAQ's you might have. I just wanted to address the escrow shortage situation as I have ALREADY received phone calls and the tax bills JUST came out! Do not ever hesitate to call your original loan officer with these kind of questions!

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