In part one of my conversation with Melissa Hudson, founder of Texas Homes Sold Group (and my personal realtor), we discussed the current housing market, whether new construction homes are attainable for first-time home-buyers, and how to find a reputable real estate agent and mortgage lender. In part two of our conversation, we talk escrow; what it is, why it’s important to understand, and how to manage the escrow account after you buy.
After 14 years as a real estate agent, and approximately 200 homes sold, Hudson knows buying, selling, and how not understanding your new escrow account can throw a wrench in your home owning journey.
Escrow is something you hear about often during the home buying process, but a lot of people don’t understand exactly what it is. Can you explain escrow?
I call it a space to park your money. Your mortgage payment consists of your principal loan, your interest, Private Mortgage Insurance (PMI), and your home insurance—the thing that covers you if your house caught fire.
What is Private Mortgage Insurance (PMI)?
The best way I can explain PMI is a guarantee to your bank that if you ever stop paying your mortgage, they have some sort of money to recoup. Everybody pays PMI, unless you're putting down a large payment amount, so the bank doesn't see you as a risk.
When people think of mortgage payments, especially as a first-time home-buyer, they tend to think of your monthly payment being stable. Can you talk a bit about property taxes and how it can impact your overall monthly payment each year?
Property tax is the one that fluctuates the most. You have some control over the other ones—you can shop around for the right homeowner’s insurance, you know what your interest rate is, know exactly what your PMI is—but your taxes; there’s nothing you can do about that.
The tax entity determines what you're paying on property taxes. They're going to send an appraiser out once a year, they're going to look at the outside of the house, look at all the other houses in the area, and they're going to make an assumption about what they think your house is worth. You can always protest that, but every year, the equity—the value of your home, which across the nation rises about 5% a year—tends to increase.
The tax county appraisal district—property tax people—will always think your house is worth so much money. If you’re going to sell it, you want your house to be valuable. But for the tax appraiser, you want them to think your house is a piece of crap.
Part of that escrow money is to pay your property tax. When you make your payments, a portion of your property taxes gets parked there and then at the end of the year [your mortgage lender] receives a tax bill [from the appraisal district]. The tax entity determines this is how much they think your house is worth. They're going to multiply it by a percentage, and this is how much property taxes you'd have to pay for it. You always want [the escrow account] to be in the green. If you're ever in the red, then you're going to owe money—meaning a higher monthly mortgage payment next year.
How can someone be proactive about keeping their escrow account in the green?
If you’ve already bought your home, the best thing to do is to be in communication with your tax office. Google the county name and the words “county appraisal district.” There you can figure out how they value your home and your neighbor's homes. At any point in time, after your first year of home ownership, you notice your escrow account is looking sad, you can send extra money directly into escrow. The last thing you want to be slapped with at the end of the year is a tax bill. A lot of people don't put enough money into that escrow account.
If you think, “Oh no this county appraisal district is getting ambitious and they're going to think I’ve got the nicest house in the block,” then send in an extra $25 or whatever you can spare each month, to put your escrow ahead a little bit. Then you tell your mortgage company, always click that box that says how to apply the extra money—to principal or to escrow.
Say at the beginning of the year your taxes came out and you have money left over [in escrow], and [the loan servicer] tries to send you a [refund] check, don't cash it. Keep [the money] in [the account]. Always keep money in your escrow account because if you don't, the next year comes around and all of a sudden, your mortgage payment went up.
When you’re buying your house talk with your mortgage lender about what amount you might want to put in escrow, so when they're figuring what your mortgage payment is going to look like, it’s a good faith estimate. You can tell them, “Hey, can we shoot a little higher? I really want to keep myself ahead, if I can afford to, because when the new year rolls around I don’t want to get slapped with an increase to my monthly mortgage payment.” That could be a car payment or insurance. You never want to be caught in that situation.
Typically, in your first one to three, maybe four years of home-ownership, if you're sending any extra on your mortgage payment, please tell your service provider to apply it to the principal because they won’t put it there automatically. The quickest way to bring your loan down is going to be in between years one and three or when you first buy the house. If you’re going to pay $50 more a month and put it toward the principal. that's a good way to bring your loan payment down. After year three or four, it doesn’t really work as much.
How does Escrow change, or how is it affected, if you're buying a new build in a new neighborhood vs a resold home in an established neighborhood?
In an established neighborhood, the mortgage company can run calculations because there are precedents in that neighborhood. They can tell you this is approximately how much you need to put in escrow every month. It's an established tax bill because they're looking at the history and the county appraisal district website.
As opposed to new construction, you're going to get the deal of the century. You're going to get the best interest rate, mortgage insurance is really good on new construction, and you're getting some incentives and perks from the company. But one thing you want to make note of—and a lot of buyers don't know this, especially if you're a new buyer—is that they're going to value the dirt [your home sits on] not the value of the home.
When they're figuring out your mortgage payment, it looks good, because the dirt could be worth $40,000, as opposed to the house you're paying for, which is probably $300,000-400,000. The tax amount that they're putting onto your mortgage payment is $40,000, because the county appraisal district is saying this is the current land value—it’s only the dirt, not the value of the home built on it. So now you're in a bind.
If you're a buyer in new construction, even if you're represented by a realtor, remember your relationship with a mortgage lender is yours alone. The realtor has an established relationship with the lender, but it's your mortgage loan. That mortgage lender is the money man, you make sure you tell them to estimate how much they think this home is going to be worth and give you the true escrow amount you need to put away for taxes monthly.
That means your monthly mortgage payment may go up $150 or $200. You would rather put that money in escrow every single month than get hit at the end of the year with a tax bill because your home’s value went from $40,000 to $350,000. Then, suddenly, you can't afford your mortgage. Make sure if you're going to buy a new construction home, the mortgage lender is well aware you don't want to be surprised on that first tax bill.
This interview was edited and condensed for clarity.
Perdita Patrice is a Texas-based writer and documentary filmmaker. She enjoys live music, reading, and watching TV. You can follow her on Twitter and Instagram @perditapatrice