When you finance your home, you are likely to pay your property taxes and homeowners insurance through your monthly mortgage payment. Instead of paying those bills on your own and directly to the respective providers, you pay the lender who then pays the amount to the providers in equal monthly installments using an escrow account. This helps in making sure that those bills are paid on time.
What can be included in an escrow account?
A third party account is maintained by the lender and funds are provided for the payment of property taxes and insurance on the homeowner’s behalf. Here’s a closer look at what it covers:Here’s a closer look at what it covers:
Property Taxes: Every property owner is required to pay property taxes annually. This revenue pays for your local government and school district. Lenders want to make sure your property taxes are paid as due so that the tax authorities do not place a lien on your home.
Homeowners Insurance Premiums: Lenders insist that you hold this policy in force at all times since it insures the home against damages and mishaps. Lenders retain the funds in an escrow account to cover the policy costs whenever they are due.
Another use lenders also employ it to meet monthly mortgage insurance premium costs. This additional coverage is needed if you put down less than 20 percent of the home’s value.
Why Do Lenders Use Escrow?
Lenders do this to reduce their risk and this is done via the creation of escrow accounts. They take a share of your property taxes and insurance premiums and pay them on your behalf, thus eliminating instances where you fail to make the payment or face financial constraints. This helps to avoid situations where there are tax liens or insurance cancellation that may pose threats to the investment.
In addition, it simplifies the budgeting process since your monthly cost remains the same as compared to what it would be when paying for the periodic bills. Your lender comes up with the amount to collect by at least dividing your total annual bills by twelve. When large payments are due, then the money is there in escrow account ready to be used.
What does it Mean to have an Escrow Account?
When you complete the process of buying a home and getting your loan, a portion of your monthly payments will go towards an escrow account. On a monthly basis, the lender allocates a part of your payment that is going to be used for the payment of taxes and insurance. In this case, the lender pays the bills from your escrow account to ensure that they are paid as soon as they are due.
Here is the basic process:Here is the basic process:
-
Initial escrow payment at closing: You will contribute to bringing the funds to closing in order to create the escrow account which is usual to be equal to two months of the escrow payments.
-
Monthly escrow deposits: Another part of your mortgage payment is credited to the escrow account on a monthly basis. Your lender will review your account annually and change the monthly amount that is escrowed to ensure that enough money has been saved for the next year’s payments.
-
Payments from escrow: Your lender disburses the money from your escrow account to pay property taxes and insurance when they are due. You normally get statements indicating activity in the account.
-
Escrow analysis: Every year, federal laws demand your mortgage company to assess your account of escrow and make necessary modifications for the account balance.
- Escrow account surpluses or shortages: If your balance in the account is above the mandatory minimum balance, it means that you can either be given back your extra money or have it credited back to you. Deficits could make you contribute more toward escrow for a certain time to refill the account.
What is an Escrow Waiver?
Certain types of loans also let you waive the holding of the escrow money especially if you have reached a certain amount of home value of at least twenty percent. This means that you are on your own to make payments on the taxes and insurance for the car. If there is no escrow cushion, you should be very careful to set aside adequate funds for these periodic bills.
Today, majority of the lenders still demand that escrow be paid for the initial one to five years of the mortgage. Escrow waivers also come with an extra charge in most cases for the service offered.
Advantages and Disadvantages of Escrow Accounts
Here are some key advantages and disadvantages to weigh if you have the option to waive escrow:Here are some key advantages and disadvantages to weigh if you have the option to waive escrow:
Pros:
-
The ease of having the lender deal with payments
-
There are options for avoiding extra charges that may be associated with inaccurate calculations of due dates or unexpected cash shortages.
- Fixed mortgage payment amount which is easier to predict for every month.
Cons:
-
Less control over the funds that are put aside for tax and insurance.
-
Reduces the availability of overage funds as a source of funds
- Lender may require you to escrow for the first few years regardless
The best and least stressful way to handle the taxes and insurance for most people is to have them placed in an escrow account, and this is especially important for first time homeowners. However, it can be more beneficial to accept an escrow waiver after you make enough equity in the house.
When Do Lenders Required an Escrow Account?
The only sure-fire way that one can determine whether their mortgage loan needs to have escrow is by going through the mortgage documents. All FHA, VA, and USDA guaranteed loans force the lenders to establish an escrow account for at least the initial five years.
Conventional loans also require the same thing most of the time, that is, the establishment of an escrow account. In fact, if you make a down payment lower than 20 percent toward your home purchase, lenders insist on escrow for the entire term of the loan. Although escrow may not be required initially, many lenders prefer to arrange escrow to secure the loan amount.
Bottom Line The primary purpose of escrow is to safeguard the interests of mortgage lenders and ensure the continuity of tax and insurance payments. However, for homeowners, it has the advantage of both convenience and stability of payments. Knowing how escrow works assists in making financial plans and dealing with your mortgage servicer effectively.
