A fixed-rate mortgage offers more predictable monthly payments than a variable-rate loan, but even a fixed loan amount can still fluctuate.
That’s because mortgage payments may also include property taxes and homeowner’s insurance if you have an escrow account set up with your lender. Here’s what you need to know.
Why fixed mortgage payments can go up
A fixed-rate mortgage keeps most of your housing costs the same. Principal and interest will not change, but that is part of the cost of housing. Although home repairs and maintenance are not included in your loan, some lenders include property taxes and insurance.
Those two costs are variable costs that can increase from year to year. Monthly mortgage payments are recalculated periodically to adjust for higher property taxes and insurance premiums. These costs increase as your home’s interest rate increases, and it means you may still face higher costs after paying off the principal.
How does an escrow shortfall occur?
Escrow estimates the increase in your monthly mortgage payments based on how much they expect property taxes and insurance to increase. However, if those costs are higher than expected, an escrow shortfall may occur. Not only will the borrower end up with higher debt next year, but he or she may immediately be liable for last year’s deficit.
Lenders reduce the likelihood of this risk by maintaining a cushion of up to two months’ worth of escrow payments. However, that cushion may not be enough if property or insurance taxes rise significantly. Home reassessments, new construction tax resets, property tax increases and insurance market changes are some of the things that can cause surprises.
Reviewing your annual income statement can help ensure you are on top of payments and don’t incur unexpected expenses. The statement can help identify your past expenses and projections for the coming year while showing whether your account has a deficit, surplus or deficit.
What can homeowners do when an escrow notice arrives
When the escrow notice arrives, you should start by reviewing the statement line by line, comparing last year’s estimated taxes and insurance to the actual debts paid. If the information looks correct, you usually have options, including paying the shortfall in one lump sum, accepting a higher monthly payment or spreading the payment over an agreed-upon period.
You may have higher monthly expenses now, but you may be able to offset them in the future by shopping for homeowners insurance and asking for discounts. For some homeowners, an attractive property tax assessment can be a good move.
While those efforts can help, there is no way to avoid property taxes and homeowners insurance. You can choose to pay these expenses yourself instead of putting them in escrow, but you will still need to save some money for these expenses if they increase.
