Escrow Accounts: What You Need to Know
Escrow accounts sound complicated but they are really quite simple. They are holding accounts, managed by your mortgage holder, from which your property taxes and insurance (homeowners, mortgage, flood, etc) premiums are paid. The amount needed for your escrow account is a part of your monthly mortgage amount.
Your insurance company and local tax office will send the bills directly to your mortgage holder. When these bills are due, your lender will use the funds in your escrow account and pay the bills on your behalf. By paying these bills for you, the lender is protected from tax liens and uninsured losses that you may not be able to pay.
Due to changes in property taxes and insurance premiums, the amount of your monthly mortgage payment will fluctuate once or twice per year.
If it rises, your lender will cover the difference in the short term. Eventually, it will adjust your monthly payment to make up the difference. If you overpaid, your lender will refund you this difference. Adjustments in the mortgage payment are usually quite small.
Do I Have to Maintain an Escrow Account?
In some situations, buyers can skip the escrow account and pay their insurance and tax bills themselves. Typically, this occurs when a buyer’s loan-to-value ratio is below 80 percent. Be aware, however, that a lender may charge a higher interest rate to make up for this additional risk. If you are a dedicated saver and diligent about paying your bills, skipping the escrow account makes sense. You could invest the money in the escrow account elsewhere and earn more interest on it. Otherwise, those funds are sitting in your lender’s accounts, waiting to be used for a few biannual bills.
Keep in mind that buyers need to bring money to your settlement to fund the escrow account. Depending on what bills are due and the time of the month you close, the amount owed could be significant – on top of other closing costs. Be sure to budget accordingly. Your lender can talk you through the various scenarios.
The Bottom Line
An escrow account is an easy way to make sure your taxes and insurance are paid on time. We recommend this option, especially for first-time home buyers. More experienced homeowners may prefer to pay these bills on their own and invest this money elsewhere in the interim.
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