Absolute escrow balance

What Is Absolute Escrow Balance?

The absolute escrow balance refers to the total current amount of funds held in an escrow account at any given time. Within the realm of real estate finance, particularly in mortgage servicing, an escrow account is a trust account established by a lender on behalf of a borrower to collect and disburse funds for recurring property-related expenses, such as property taxes and homeowners insurance premiums. The absolute escrow balance fluctuates as the borrower makes monthly payments into the account and the servicer makes disbursements for these various obligations.

History and Origin

The concept of escrow, derived from the Old French word "escroue," meaning a scrap of paper or a roll of parchment, has historical roots dating back to medieval Europe, where it was used to secure land transactions. A trusted third party would hold a deed or document until specific conditions were met by the buyer and seller.²¹ This practice laid the groundwork for modern escrow arrangements.²⁰,¹⁹

In the United States, formal escrow services gained prominence in the early 20th century, particularly with the growth of the real estate market.¹⁸,¹⁷ The institutionalization of mortgage payment escrows during the Great Depression in the 1930s was a significant development. Lenders began collecting a portion of anticipated annual property taxes monthly alongside mortgage payments to help homeowners avoid losing their homes due to large, infrequent tax bills.¹⁶ This became standard practice, and by 1934, the Federal Government mandated that lenders manage escrows for all Federal Housing Administration (FHA) insured mortgages.¹⁵ Over time, regulations such as the Real Estate Settlement Procedures Act (RESPA) were enacted to govern these accounts, ensuring consumer protection and outlining requirements for escrow account management by financial institutions.¹⁴ The Consumer Financial Protection Bureau (CFPB) now enforces regulations related to escrow accounts, detailing requirements for their establishment, maintenance, and analysis.¹³

Key Takeaways

• The absolute escrow balance is the actual amount of funds currently held in an escrow account.
• It is dynamic, increasing with borrower contributions and decreasing with payments for taxes and insurance.
• Servicers conduct regular analyses of the absolute escrow balance to ensure sufficient funds for upcoming disbursements.
• Regulations govern how servicers manage and analyze the absolute escrow balance, including rules for surpluses and shortages.
• An understanding of the absolute escrow balance is crucial for both mortgage borrowers and the financial institutions that manage these accounts.

Formula and Calculation

While there isn't a "formula" to calculate the absolute escrow balance in the same way one calculates a return on investment, it represents the cumulative effect of deposits and disbursements over time. Conceptually, the absolute escrow balance at any given point is:

Where:

• Beginning Balance: The balance in the escrow account at the start of a period.
• Monthly Escrow Payments: The portion of the borrower's monthly mortgage payment allocated to the escrow account.
• Disbursements: Payments made from the escrow account for expenses like property taxes and homeowners insurance premiums.

Mortgage servicers typically perform an aggregate analysis to determine the appropriate amount a borrower needs to pay into the escrow account and to assess whether the absolute escrow balance will be sufficient to cover upcoming expenses, while also adhering to regulatory cushion limits.¹²

Interpreting the Absolute Escrow Balance

Interpreting the absolute escrow balance involves comparing it against the projected future expenses it is intended to cover. A servicer's primary goal is to maintain an adequate absolute escrow balance to ensure timely payment of recurring property-related costs such as property taxes and homeowners insurance.

During the annual escrow analysis, the servicer projects the anticipated disbursements for the next 12 months and compares this to the expected inflow of funds from the borrower's monthly escrow payments. This analysis reveals whether the account has a surplus (more funds than needed), a shortage (not enough funds), or a deficiency (a negative balance). The Consumer Financial Protection Bureau (CFPB) provides detailed guidelines on how servicers must conduct these analyses and address any imbalances.¹¹ For example, if a significant surplus exists, the servicer may be required to refund the excess to the borrower.¹⁰ Conversely, a shortage or deficiency typically results in an adjustment to the borrower's monthly escrow payment to make up the difference over the next year.

Hypothetical Example

Consider a hypothetical scenario for a homeowner, Jane, with a mortgage.

Initial Setup:

• Annual Property Taxes: $3,600
• Annual Homeowners Insurance: $1,200
• Total Annual Escrow Expenses: $4,800
• Monthly Escrow Payment: $4,800 / 12 = $400

Escrow Activity over a Few Months:

• Month 1 (January): Jane makes her $400 escrow payment.
  • Absolute Escrow Balance: $400
• Month 2 (February): Jane makes her $400 escrow payment.
  • Absolute Escrow Balance: $800
• Month 3 (March): Jane makes her $400 escrow payment.
  • Absolute Escrow Balance: $1,200
• Month 4 (April): Jane makes her $400 escrow payment. On April 15th, the servicer pays the annual homeowners insurance premium of $1,200 from the account.
  • Balance before disbursement: $1,600
  • Absolute Escrow Balance after disbursement: $1,600 - $1,200 = $400
• Month 5 (May): Jane makes her $400 escrow payment.
  • Absolute Escrow Balance: $800

This simple example illustrates how the absolute escrow balance grows with borrower contributions and decreases with periodic disbursements, never staying static.

Practical Applications

The absolute escrow balance is fundamental to effective loan servicing and compliance for financial institutions. Its practical applications include:

• Mortgage Payment Calculation: The monthly principal and interest payment, along with the escrow portion, constitutes the total monthly mortgage payment. Servicers must accurately calculate the escrow component to ensure sufficient funds are collected.
• Regulatory Compliance: Regulatory bodies like the Consumer Financial Protection Bureau (CFPB) and the Federal Reserve impose strict rules on how servicers manage escrow accounts. These include requirements for annual escrow analyses, disclosure of account activity, and handling of surpluses or shortages. The Real Estate Settlement Procedures Act (RESPA) outlines specific rules for escrow account management.⁹ Federal Reserve examinations in 2023, for instance, found that violations of RESPA requirements related to escrow accounts were among the top compliance issues for banks.⁸
• Risk Management: For servicers, maintaining an appropriate absolute escrow balance is a key aspect of risk management. Underfunded escrow accounts could lead to servicers having to advance funds to cover property taxes or insurance, while excessively large balances might draw regulatory scrutiny or consumer complaints.
• Consumer Protection: From a borrower's perspective, the absolute escrow balance directly impacts their financial planning. Regular statements detailing the absolute escrow balance and projected activity help borrowers understand where their funds are going and anticipate changes in their monthly payments. Some states even mandate that banks pay interest on these funds to prevent lenders from receiving interest-free loans from borrowers.⁷
• Real Estate Transactions: Beyond mortgage servicing, escrow accounts are used in various real estate transactions to hold funds or documents, such as earnest money deposits or deed transfers, until all conditions of a contract are met, providing security for both buyers and sellers involved in closing costs.

Limitations and Criticisms

While essential for managing property-related expenses, escrow accounts and their absolute balances are not without limitations or criticisms:

• Lack of Interest Earned (in some cases): A common criticism from borrowers is that funds held in escrow accounts typically do not earn interest for the borrower, or earn a very low rate, depending on state laws. This means the financial institution managing the account benefits from holding these funds, while the borrower does not. This issue has led to legal challenges, with some states requiring interest to be paid on escrow accounts, a point of contention with national banks.⁶,⁵ For example, New York's law requiring a minimum of 2% interest on escrow accounts has been the subject of Supreme Court review, highlighting ongoing debates about state versus federal regulatory authority over such matters.⁴
• Payment Fluctuations: Due to changes in property taxes or homeowners insurance premiums, the monthly escrow payment component can change annually, leading to unexpected increases for borrowers. This can sometimes result in a shortage in the account, requiring a larger monthly payment or a lump-sum payment from the borrower to rebalance the absolute escrow balance.
• Servicer Errors: Errors in escrow analysis or mismanagement by the loan servicer can lead to inaccuracies in the absolute escrow balance, resulting in unjustified shortages or surpluses. These errors can cause frustration for borrowers and lead to compliance issues for servicers, as highlighted by regulatory bodies.³
• Required Cushions: Regulations allow servicers to maintain a "cushion" in the escrow account, typically up to one-sixth of the estimated total annual disbursements (equivalent to two months of escrow payments).² While intended to protect the servicer against unanticipated increases in property taxes or insurance, some argue this requires borrowers to maintain more funds in escrow than strictly necessary.

Absolute Escrow Balance vs. Target Escrow Balance

The absolute escrow balance is the actual amount of money currently present in an escrow account at any moment. It is the real-time, "snapshot" figure of the funds being held.

The target escrow balance, also sometimes referred to as the "minimum required escrow balance" or "low point," is a projected figure determined by the loan servicer during the annual escrow account analysis. This target represents the lowest point the account balance is expected to reach over the next 12-month period, after accounting for all anticipated disbursements and including any legally permissible cushion. The purpose of the target escrow balance is to ensure that there are always sufficient funds in the account to cover upcoming expenses, even if a large payment, like an annual property tax bill, is due shortly after a borrower's monthly payment.

The key difference lies in their nature: the absolute escrow balance is a factual, present amount, while the target escrow balance is a calculated, forward-looking benchmark used to manage the account and determine appropriate monthly contributions.

FAQs

Q: What happens if my absolute escrow balance is too low?
A: If your absolute escrow balance is too low to cover anticipated expenses, it indicates a shortage or deficiency. Your loan servicer will typically adjust your monthly escrow account payment upward to collect the shortfall over the next 12 months, or they may offer a lump-sum payment option.

Q: Can I get money back from my absolute escrow balance if there's a surplus?
A: Yes, if your annual escrow analysis reveals a significant surplus in your absolute escrow balance, regulations often require your servicer to refund the excess amount to you, provided the surplus meets a certain threshold (e.g., $50 or more).¹

Q: Why does my monthly escrow payment change if my absolute escrow balance is just the amount in the account?
A: Your monthly escrow payment changes because the servicer performs an annual analysis that looks at both your current absolute escrow balance and the projected property taxes and homeowners insurance premiums for the upcoming year. If those projected costs increase, or if there was a shortage in the previous year, your monthly payment will be adjusted to ensure the absolute escrow balance will be sufficient for the next cycle.

Q: Is the absolute escrow balance the same as my total mortgage payoff amount?
A: No, the absolute escrow balance is only the funds held for taxes and insurance within your escrow account. Your total mortgage payoff amount includes the remaining principal and interest on your loan, plus any outstanding fees. The escrow balance is a component of your overall mortgage management but not the full outstanding debt.