When you get a mortgage, the lender usually adds the property taxes and insurance premiums to the monthly payment, setting aside the money in an escrow account to make sure those obligations are paid on time. This protects the lender from tax liens and uninsured losses that the borrower can’t repay.
The lender typically will cover any shortfalls until it can adjust your monthly payment to make up for increases in tax rates and insurance premiums. Your monthly mortgage payment will fluctuate from year to year, even for a long-term, fixed-rate loan.
Lenders differ on escrow
In some cases, you can avoid escrow. Some lenders allow you to pay your own property taxes and home insurance premiums, especially if your loan-to-value ratio is below 80 percent. But don’t be surprised if the lender increases your interest rate to compensate for the additional risk it is assuming.
Once an escrow requirement is in place, it can be difficult to persuade a lender to cancel it. If your loan is sold, as is common, and there is nothing in the lending agreement that provides for cancellation of the escrow requirement, you’ll have to live with the decision of your new mortgage servicer.
Should you avoid escrow?
Should you set up an escrow account or take responsibility for paying property taxes and homeowners insurance — which often are large sums — on your own?
Here are some questions to ask if you’re trying to determine whether to establish an escrow account.
1. Am I a good saver?
If you’re not good at saving money, you’re better off having an escrow account, says Adriana Mollica, an agent with Teles Properties in Beverly Hills, California. If money burns a hole in your pocket, it may be tempting to spend what you set aside for taxes and insurance on a pricey vacation instead.
“There’s always a different reason for different people” to use or not use an escrow account, Mollica says. “The reality is, not everybody’s equal.”
Escrow accounts can help homeowners with their budgeting since insurance rates and tax bills change.
However, borrowers whose monthly income fluctuates because they are self-employed or earn commissions have more flexibility if they pay for insurance and taxes directly, says Joe Chatham, who ran Chatham Mortgage Partners Inc. in Westlake Village, California, for 15 years. They can set aside extra money in months when their earnings are strong.
2. Where else can I put my cash?
If you’re good at saving money, it doesn’t make sense to let the bank collect from you every month to pay bills that come due only once or twice a year. “It’s free money for the banks,” Mollica says.
If you don’t like handing over your money to the bank each month and are wary of the stock market, consider savings, money market accounts and certificates of deposit as alternative places to park your money. Even if the rates are not great today, they will go higher in the long term, Mollica says.
3. Will it make a difference with my bank?
Setting up an escrow account with your lender could result in you being offered a lower interest rate on your loan, which can bring substantial savings over the long term, Chatham says.
But homebuyers also need to take money to the closing table to fund the escrow account. Depending on the month you close and the month that the tax and insurance bills are due, it could add up to a hefty sum.
4. Whose responsibility is it to pay?
If you have an escrow account, it’s the lender’s responsibility to pay all of your tax bills in a timely fashion. In some places, homeowners have to pay separate tax bills to the county, school district, and water and sewer districts, rather than having them rolled together into one county tax bill.
The mortgage company must pay every jurisdiction you pay taxes to. If the lender drops the ball and misses a payment, it’s their responsibility to pay penalties. There are horror stories of lenders failing to make insurance and tax payments, but that rarely occurs.
If you don’t pay your homeowners insurance on time, coverage could lapse and that could result in your insurance company either charging you more or declining to renew your policy.
There also can be major problems if you forget to pay your taxes, says Chantay Bridges, a Realtor with TruLine Realty in Los Angeles. You could wind up with a tax lien on your property, and it will be impossible to sell your home until it’s cleared up.
Using an escrow account and not having to pay those obligations out of pocket relieves you of any worries about whether those payments were received on time, Bridges says. On the other hand, that’s money you could save and grow.
Once you consider the pros and cons of both scenarios, you can decide what’s right for you.