Your Mortgage Payment Can Jump Even With a Fixed Rate — Blame the Escrow Line
A fixed-rate mortgage offers more predictable monthly payments than a variable-rate loan, but even a fixed-rate mortgage can still fluctuate.
That’s because mortgage payments can also cover property taxes and homeowners insurance if you have an escrow account set up with your lender. Here’s what you need to know.
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Why a fixed mortgage payment can increase
A fixed-rate mortgage makes most of your housing expenses stay the same. The principal and interest will not change, but that is only part of housing costs. While home repairs and maintenance aren’t included in your mortgage, some lenders include property taxes and insurance.
Those two costs are variable expenses that can increase each year. The monthly mortgage payments are periodically recalculated to adjust for higher property taxes and insurance premiums. These costs increase as your home gains value, and it means you may still face rising costs after paying off the principal.
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How escrow shortages happen
Escrows estimate hikes to your monthly mortgage payments based on how much they expect property taxes and insurance to increase. However, if those expenses go higher than expected, an escrow shortage can take place. Not only will the borrower likely end up with a higher bill next year, but they may be immediately responsible for the previous year’s shortage.
Lenders minimize the likelihood of this risk by keeping a cushion of up to two months’ worth of escrow payments. However, that cushion may not be enough if property taxes or insurance spike sharply. Home reassessments, new construction tax resets, local tax hikes and insurance market changes are some of the factors that can result in a surprise.
Reviewing your annual escrow statement can help ensure that you are on top of payments and not about to incur a surprise expense. The statement can help identify your previous costs and projections for next year while indicating if your account has a shortage, surplus or deficiency.
What homeowners can do when the escrow notice arrives
When the escrow notice arrives, you should start by reviewing the statement line by line, comparing last year’s projected taxes and insurance with the actual bills paid. If the information looks correct, you generally have choices, including paying the shortage in a lump sum, accepting a higher monthly payment or spreading repayment over the allowed period.
You may have a higher monthly expense now, but you may be able to trim it in the future by shopping for homeowners insurance and asking for discounts. For some homeowners, appealing property tax assessments can be a good move.
While those efforts can help, there is no way to avoid property taxes and homeowners insurance. You can opt to pay these expenses on your own instead of lumping them into escrow, but you will still have to save some extra money for these costs if they rise.