What is an Escrow Account?
Your monthly mortgage payment includes the money that is put into your escrow account, basically 1/12 of your property taxes and homeowner insurance premium are included in your monthly mortgage bill.
If you recently purchased a house, one of the first questions you may have when you open your monthly mortgage statement is what is an escrow account and why am I paying money into it every month.
Escrow accounts are used to pay your property taxes and homeowners insurance premiums. A mortgage lender usually requires them because it gives them peace of mind that important bills related to their investment (your home) are paid on time.
Escrow accounts can be confusing and complicated. We have put together a brief overview of what an escrow account is and why your mortgage lender will often require it.
What is Escrow?
Escrow accounts are simply a savings account that holds money, which is being used to pay for certain expenses that are related to your mortgage. In the majority of cases, an escrow account is held in conjunction with your mortgage lender and it will stay in affect until your mortgage is paid off.
An escrow account is usually used to pay your property taxes and your homeowners insurance premium. This makes it easier for you by breaking up your property taxes and homeowners insurance into monthly payments instead of delivering a large bill once a year. In addition, it gives your mortgage lender peace of mind that your insurance and property taxes will be paid on time.
Your monthly mortgage payment includes the money that is put into your escrow account, basically 1/12 of your property taxes and homeowner insurance premium are included in your monthly mortgage bill.
If you carry additional insurance, such as flood or earthquake coverage, these premiums may be escrowed as well.
Do I Have to Use an Escrow Account?
In most cases it is possible to forgo an escrow account and pay your own property taxes and homeowner insurance premiums. If your loan to value ratio is below 80 percent your odds of dumping your escrow account are higher.
However, you may end up paying a higher interest rate on your mortgage if you decide to turn down an escrow account. An escrow account ensures that your insurance and property taxes will be paid on time, which lowers your lenders risk and in many cases they will offer a lower interest rate.
If you plan on opting out of an escrow account you should do it before the loan closes. The majority of mortgages are sold and once an escrow account is established and the loan is sold it can be very difficult or even impossible to cancel an escrow account.
What Isn’t Covered by Escrow
While an escrow account is great for certain monthly expenses such as insurance and taxes it doesn’t cover other monthly bills.
Bills for your water, sewer and homeowner association dues are not covered by an escrow account.
In addition, special assessments from your local taxing authority are not covered by an escrow account, these types of bills will need to be paid out of pocket.
Things to Consider
Escrow accounts are often required but if you are hoping to dump your escrow account and go it alone here are a few things to consider:
Are Your Financially Responsible: The bills paid by an escrow account are very important. If you fail to pay your homeowners insurance premium and your home burns down you will be covering the cost of repairing or rebuilding the home on your own. Your mortgage lender will still expect to be repaid as well. Property taxes are also an extremely important bill to pay on a timely basis.
If you are financially responsible and are confident that you will be able to save the required funds to cover taxes and insurance, dumping your escrow account may be a good idea. However, if are consistently late with your bills, have an income that can fluctuate or often spend more than you earn, sticking with an escrow account is ideal.
Your Interest Rate May be Higher: The use of an escrow account helps keep your mortgage lender up to date when it comes to your insurance premium and property taxes. They will know if you miss a payment on your insurance policy and can take steps to make sure their investment is protected by force placing an insurance policy on your home.
If you are handling the insurance premium on your own they may not be aware until your policy has lapsed. Due to this increased risk there is a good chance you will end up paying a higher interest rate on your mortgage.