Escrow accounts are accounts in which money is stored on behalf of one party and used for a particular purpose. In real estate, escrow accounts are used by lenders to hold payments for a variety of costs. This is where the aggregate accounting method is used, a way of measuring both how the escrow account is recorded and viewed and how much money that it holds. Most lenders use the aggregate method to make the escrow process simple.
The aggregate accounting method is simply a way for lenders to easily account for escrow payments. Often, lenders must use escrow funds to pay for a variety of housing costs, including property taxes, mortgage insurance and related fees. Rather than creating an escrow account for each one of these fees, the lender approaches collection via the aggregate method. A single escrow account is create and payments are gathered in aggregate and disbursed when needed to paid for funds.
A cushion is the amount of money a lender collects over the amount that should be needed to make payments. When money is gathered in aggregate, it can be difficult for lenders to account for any potential changes in fees. Rather than being stuck without enough money in the account, they create a cushion amount so that unexpected changes can still be paid for. This cushion amount is typically for a certain period, such as two months.
Cushions for aggregate escrow accounts do have their limitations, often decided by a mixture of state law and individual lender practices. For example, lenders may not be able to exceed one-sixth of the total estimated annual payments that the escrow account will need to meet all fee requirements. These rules keep lenders from collecting large sums of money in the accounts and then using them for other business purposes.
Lenders using the aggregate method will also conduct analysis of the escrow account periodically, especially when first implementing the method but also annually or quarterly afterward. This analysis will explore property tax changes, insurance fee changes and other developments. The lender will then adjust the estimated annual escrow amount accordingly, which will change the amount the lender asks of the borrower each month.