First time homebuyers have to put money in the escrow account
At the closing where you get the keys to your first home, you will set up a fund to pay for the property taxes and the homeowners insurance. On page two of the closing statement, you will see a small money pit. On line 1001 of the HUD closing statement, there is a payment to start the escrow account with homeowners insurance. You look above that on line 903 and you see that you just bought a one year homeowners insurance policy. So, what is this for?
Every month as a part of the mortgage payment the lender will collect some money to apply to purchasing next year’s homeowners insurance policy. The payment at closing begins the account that collects this money. The lender wants to have a couple of months worth of this payment as a reserve to be sure there will be enough money in the account next year to buy the homeowners insurance policy.
On lines 1003 and 1004 of the HUD closing statement, there are payments for property taxes that also go into the escrow account. In a similar manner, the lender wants to have a couple of months worth of this payment in reserve so that there will be enough money to pay the property taxes when they are due. By the way, property taxes can be paid when the bill comes out, but hardly anyone pays them then, as there is no penalty on the payment until the beginning of the next calendar year. So, your lender will pay the taxes at the end of the year.
On line 1008 of the HUD closing statement. there is a number with a minus sign in front of it. The Real Estate Settlement Procedures Act (RESPA) sets a limit on how much of a reserve the lender may collect, which is generally two months of payments. Before laws were enacted to limit these reserves, some lenders collected excessive amounts for their escrow accounts because the lenders did not have to pay interest to the homeowner on the amount collected. This number on line 1008 subtracts from the reserves the bank would like to have in order to reach an amount that is allowed under federal law.
At the closing, not only will the taxes be pro-rated and a one year insurance policy purchased, but an escrow account will be set up to start a fund that will pay for the taxes and insurance. Then, each month, your mortgage payment will include some money for taxes and insurance that will go into this fund so that there will be enough money to pay the tax bill and insurance premium when they come due.