Apr. 7th, 2007

livingdeb: (Default)
The following must be a very complicated topic because I have never ever seen anything written on the subject. But you are in good hands here, and this will not be scary.

A year after you buy your house, your payment may go up by a shocking amount. When this happened to me, I thought, "Hey, the whole point of buying a house (using a fixed-rate loan) is so my payments don't increase by shocking amounts." After much study of the paperwork I was sent, I figured out the problem and that it would happen only the first year.

All of this is an artifact of having an escrow account. If you don't have an escrow account, this won't happen to you.

An "escrow account" is where the lender does not trust that you will pay your taxes or your insurance payments or your mortgage insurance on your own, so they take charge of paying for it. To do this, they collect extra money from you each month in an escrow account so that when these payments come due, they have the money available to pay your bill. They always pay on time because if anyone gets to repossess your house, they want it to be them.

(An escrow account is also a fabulous way to keep charging you interest when you try to pay your loan off early. Because if you don't say you want to apply the payment to your principle, they get to say they didn't know what you wanted to do with the money, so they add it to your escrow account.)

Now I'm guessing that if they could, lenders would ask for much more money than they actually need for the escrow account, so some laws had to be passed, because here's what happens. They know what your insurance payment is going to be ahead of time, but unless you bought your house at the right time of the year, they don't know what your taxes are going to be. And so they estimate that these will be the same as last year, even though everyone and their dog knows it will be higher.

But then to make up for that, they get to collect extra money to act as a cushion. My statement explains: "Section 10 of the Real Estate Settlement Procedures Act (RESPA) authorizes lenders to collect and maintain up to one-sixth of your total disbursements in your escrow account at all times. The required reserve is used to cover increased tax and insurance disbursements." As you can see, they are not clear on whether this cushion is merely "authorized" or "required," but knowing lenders, I'd say it's just about guaranteed. So, they divide everything up by 12 months, then add an extra sixth, and that's your new escrow payment, which is added on to your same old principle-and-interest (P&I) payment (if you have a fixed-rate loan) to get your new total.

Here's the problem with the first year. First, they have underestimated the amount that you should have been paying, so they take that extra amount, divide it by twelve and add it onto your monthly payment for the next year. (Or they give you the option to pay it right now. In their dreams!)

But then, next year's estimate is going to go up from last year's estimate, so they're going to add that increase again. Thus: shocking increase.

Now every year after that, you're used to having some kind of escrow "shortage spread" added to your payment, so it's not so bad.

Example:

Year 1: $505 P&I + 240 escrow = $745 total
Year 2: $505 P&I + 260 escrow + 20 shortage spread = $785 total
Year 3: $505 P&I + 284 escrow + 24 shortage spread = $813 total
(taxes went up more, but your payment went up less)

**

This year, for the first time, my payment is going down. This means that last year's taxes must have increased less than they did the previous year, so my escrow shortage spread is much lower.

Example:
Year 4: $505 P&I + 290 escrow + 8 shortage spread = $803 total

My actual gain is $6 per month, but still, it's fun. Hmm, maybe I should increase my retirement contribution by $6 per month. Hee hee! Or save it up for next year's increase, which will probably be a bit shocking again.

**

I suppose I should ask my lender if they will drop the escrow account and let me make my own payments. I've heard this is possible.

Then I can do that thing where I pay the tax just before the new year half the time and just after the new year half the time and then take the standard deduction on my income taxes those years when I don't pay property taxes and take the itemized deductions those years when I pay double.

But I probably won't get around to it.

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livingdeb

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