If there is one thing people debate about getting a new mortgage is whether or not they really need an escrow account. To be honest, these accounts are not meant to punish you or make you struggle – they were created to help keep you on track. They protect the bank as well as yourself as the county has first lien on your property should you default on your taxes. If you have your taxes and homeowner’s insurance saved for you in a specific account, you do not have to worry about these things. Isn’t it worth the peace of mind it provides?
What is the Escrow Account?
An escrow account is an account the lender holds for you. In this account, they place the money from your monthly mortgage payment that pays your real estate taxes and homeowner’s insurance. The amount you pay each month is 1/12th of the annual premium. For example, if your real estate taxes are $5,000 every six months or $10,000 per year, your mortgage lender would add $833.33 per month onto your mortgage payment. They would then place $833.33 into the account set aside for escrow each month. They do the same thing for your homeowner’s insurance.
When the date nears the due date of your real estate taxes and/or homeowner’s insurance, the lender pays the bill for you. In fact, most of the time you do not even see a bill as it goes directly to the lender. If there is not enough money in the account to cover your taxes or insurance because of a premium or rate hike, the lender will adjust the amount you put in your escrow account very month to make up for the shortage.
What are the Benefits of Escrowing Taxes and Insurance?
As you can guess, there are many benefits to escrow your taxes and insurance. They include:
- Avoid failure to pay – If you did not have an escrow account set up, it is your responsibility to pay the taxes and insurance. What if despite your best intentions, you overlooked the fact that you have to save an extra $800 per month for taxes? Even if you forgot for a month or two, you could end up $1600 or more short for your tax bill that is due now. Paying taxes late usually results in hefty fines and penalties, not to mention the fact that you could lose your property if you let it go too long.
- Convenience – Consider the fact that the lender wants to help you pay your taxes and insurance a convenience. You do not have to worry about managing these two bills. In addition, it is fewer checks you have to write in the long run. What if you forgot to pay the taxes or insurance? You do not want to think of the consequences of these actions.
- Savings is done for you – If you are not a saver by nature, you could find it hard to sock away $800 or more per month. If you know you will find other reasons to use the money and will not just leave it in an account for later use, it is best to let the lender handle it for you.
What are the Downsides of an Escrow Account?
Every up has its down and that includes escrow accounts. Yes, you can have the peace of mind knowing your taxes and insurance are always paid, but what if you are financially responsible and like to handle your own finances? There are a few downsides to this account:
- No interest – An unfortunate side of setting up an escrow for your taxes and insurance is that you do not see a dime of interest on your money. The account that the lender sets up is not an interest bearing account. If you are good at investing and know that you could make a little money while saving your money for taxes and insurance, you might want to avoid escrow.
- Changing mortgage payment – Taxes and insurance rates always change, which forces the lender to change your escrow payment accordingly. Because of this, you might find that your mortgage payment changes year after year. Some years it might go down, while others it might increase. If you prefer a stable payment, setting up escrow might not work in your favor.
- Higher interest charges – Setting up an escrow helps the lender know that your taxes and insurance will always be paid on time. If you choose to avoid escrow, the lender will likely charge you at least a 0.25% higher interest rate to make up for the risk that you now pose to the lender. In fact, not everyone qualifies to avoid escrow. If you do not have good credit or have a high DTI, the lender might force an escrow on you.
How to Avoid Escrow
Generally, you have to put down at least 20 percent on your home in order to avoid escrowing your taxes and insurance. This is the case for conventional loans at least. A few other loan programs almost always require an escrow account no matter what. These programs include:
There are no exceptions to the rule with FHA and VA loans – you have to have an account set up for you. Conventional loans, on the other hand, do allow waivers as long as you have lower than an 80% LTV. Keep in mind, though, that the servicing lender will still monitor your taxes and insurance, making sure they are always on time. If you default, the lender has the right to enforce an escrow account on your mortgage once again.
Setting up an escrow for your taxes and insurance is not as bad as it seems. Despite the fact that you do not make interest on the money you put aside, the remaining benefits make it well worth it. If you want to avoid setting up an escrow account, you have to have the credentials to do so. Talk to your lender to see what they can offer you in terms of skipping escrow if that is what you desire.