Mortgage Escrow Account: Execs and Cons
If you own a home and make monthly payments, you’ve probably read the breakdown of your monthly mortgage fees once or twice. Your mortgage payment will likely break your monthly payment into three parts: principal, interest, and funds that will be deposited into your escrow account.
While you probably know that principal is how much of your monthly payment will be used to pay down the amount you borrowed, and interest is what you pay the lender for using their money to buy your home. What you may not know so well is what escrow is. What does escrow account pay for?
Check your mortgage rates
Check out our top notch lenders and find the best rates today. It’s quick and easy.
The escrow account associated with your mortgage holds the money for your taxes and homeowner insurance premiums. Your lender collects the money to pay your property taxes and homeowner insurance premiums as part of your monthly payment and then uses that money to pay those bills. This can come in handy, but there are a few other pros and cons that you’ll need to have accounts about.
What is a Mortgage Escrow Account?
A mortgage escrow is an account that your lender or mortgage service provider has set up to hold the money you pay them for taxes and insurance. The lender pays your local property taxes and homeowner insurance from this account when they become due. Depending on where you live, you can pay property taxes once or twice a year. Insurance premiums are usually paid annually.
You pay into the escrow account with every mortgage payment. The lender estimates how much your taxes and insurance will cost for the year, divides the total by 12, and adds that number to your mortgage bill each month. This way, the money needed to pay the bills is in the escrow account when the bills are due.
An escrow account can be a convenient way to save the money on the important bills that come with home ownership. If you fail to pay your property taxes, the county can place a lien on the house. If you fail to pay for several years, the county can sell the property to recoup the taxes owed. If you fail to pay your insurance premium, the insurer will cancel the policy and you will not be covered if your home is damaged in a fire or storm.
[ See: How to Negotiate Mortgage Closing Costs ]
Escrow account used
Lenders use an escrow account to hold your money until the tax bill or insurance premium is due. Some lenders may also deposit fees for homeowners associations. The lender protects the investment made in your home by making sure taxes and insurance are paid, avoiding tax liens and uninsured disasters.
You start depositing into escrow when you close your mortgage. Upon completion, your initial escrow payment will likely be one-sixth of the expected property tax bill and insurance premium for the home, but it can vary by lender. Then you pay monthly.
When your property tax or insurance premium is due, the mortgage servicer will withdraw and pay the money. If your bill is higher than expected and there is not enough money in the account, the servicer will pay the amount. (Eventually you will make up for the shortage.)
Once a year, the lender needs to analyze your escrow account to make sure that it is collecting enough money but not collecting too much of your payment. The lender can maintain a “pillow” equal to one-sixth of your annual escrow amount as a reserve in case taxes or insurance costs increase.
If the lender hasn’t raised enough, your mortgage payments will be increased to cover the amount required, including any money the lender paid out for taxes or insurance due to a deficit.
If the lender has raised too much, you can get a refund and your mortgage bills for the next year may fall.
Benefits of the Mortgage Escrow Account
You can use an escrow account to pay your taxes and insurance in installments. The benefits of an escrow account include:
- Convenience: When your lender handles your tax bill and insurance premium these issues are lifted off your plate. You don’t have to keep track of when the bills are due, where to send the check, and whether you have the money in your account.
- No big bills: If you don’t file your taxes, you could count on a property tax bill of several thousand dollars a year. If you can save and budget well, that bill might not be a problem, but many people find it difficult to raise these funds. It’s often easier to pay off the amount in 12 monthly installments as part of your mortgage payment.
- Unexpected tax increases: Tax burdens can increase for several reasons. Perhaps your county raised the tax rate or checked your home for a higher valuation. If your tax bill goes up, you will get a bigger bill than you expected and that can be a drain on your budget. When you deposit your taxes, the lender covers the immediate shortfall and you make the difference in repaying the lender.
[ Read: Best Homeowners Insurance Companies ]
Disadvantages of the Mortgage Escrow Account
While escrow accounts are convenient for some people, others see them as a disadvantage. Some of the disadvantages are:
- Higher closing costs: Because your lender may charge up to one-sixth of your total annual tax and insurance payments at closing, you will face higher closing costs if you already have cash to pay for a down payment and other fees.
- Difficult to get rid of: The rules vary depending on the type of loan, but in general it can be difficult to exit an escrow account. When you have an FHA loan, you must have an escrow account. VA loans don’t specifically require one, but lenders usually insist on an escrow account to ensure you meet VA requirements for insurance and timely tax payments. Most lenders require an escrow account when they have a traditional loan. However, you can work around it if you cut at least 20%.
- Lost opportunity cost: If your money has been in escrow for months, you lose the option to earn interest or capital gains on that money. Once you’ve managed the money yourself, you can invest it or put it in an interest bearing account until you need it.
Compare top mortgage lenders
Too long, not read?
Your mortgage lender uses an escrow account to hold the money needed to pay your property tax bill and homeowner insurance. The agreement enables the lender to ensure that these bills are paid on time, and provides a convenient way for you to save the amount required in manageable installments.
While some people dislike escrow because they can’t invest the money until it is needed to pay a bill, for many people the benefits of having an escrow outweigh the disadvantages. Ultimately, escrow accounts are a good idea because they protect you and your lender’s investment in your home, which is one of the most important factors in this equation.
We appreciate your feedback on this article. Contact us at firstname.lastname@example.org with any comments or questions.