Escrow Payments

• If you're like many homeowners, you won't actually pay your property taxes and homeowners insurance premiums yourself. Instead, your mortgage lender will collect money from you every month, place it in an escrow account, and then pay those bills when they come due. Lenders take several factors into account when determining your escrow payment, but you can get a general estimate by adding up the total annual cost of your taxes and insurance, then dividing by 12. Your escrow payment is usually just tacked onto your monthly mortgage payment, though in some cases homeowners will make separate payments. However much money you have in escrow at any given time is your escrow balance.
  
  

Adjustments

• Your escrow balance should be large enough to pay your tax and insurance bills when they're due. If there's a $1,500 property tax payment due, for example, there should be at least $1,500 in your escrow balance. If there isn't, your lender might cover the shortfall, but you'll be expected to make up the difference. Shortfalls can occur when taxes and insurance premiums rise. Your lender will probably adjust your escrow payment periodically so it keeps pace with your bills.
  
  

Cushion

• To avoid having to cover shortfalls -- either from rising tax and insurance costs or from missed escrow payments -- many lenders require borrowers to maintain a minimum escrow balance at all times, known as a "cushion." For example, say your annual taxes come out to $3,000, and your annual insurance premium is $600. If you pay $300 a month into escrow -- $3,600 a year -- there should be enough money in the escrow balance to pay those bills when they come due. But if your taxes jump up to $3,300, the balance might come up short. So the lender might require you to keep an additional $500 in escrow as a cushion to absorb such increases.
  
  

Escrow Law

• A federal law, the Real Estate Settlement Procedures Act, regulates mortgage escrow accounts. It requires lenders to make all payments out of escrow on time; borrowers have the right to sue if they fail to do so. RESPA gives states the right to require lenders to pay interest on escrow balances, although the federal law itself doesn't require it. And RESPA limits how big of a cushion a lender can require. Under the law, the lender can maintain a cushion equal to one-sixth of the total costs paid out of escrow every year. In essence, this means the maximum cushion is about two months' worth of escrow payments. RESPA allows states to set lower limits on cushions; if they do, the lower limit applies.