Escrow accounts help homeowners set money aside each month to cover insurance premiums and property taxes. When the bills for these come in each year, the mortgage lender uses money in the escrow account to cover the payments. So you avoid making large payments in one shot each year. A financial advisor can also help you manage money the right way to cover all costs related to buying a home.
Find out now: How much house can I afford?
How Escrow Accounts Work
An escrow account (or an impound account), is a special account that holds the money owed for expenses like mortgage insurance premiums and property taxes. If you’re buying a home, your lender might collect a certain amount of money and deposit it into your escrow account during the closing process.
The actual dollar amount that goes into an escrow account is based on what insurance premiums and taxes average out to on a monthly basis. You may have to pay up to six months’ worth of property taxes and maybe even a year’s worth of insurance up front.
Escrow accounts are set up to collect property tax and homeowners insurance payments each month. When your insurance or property tax bill comes due, the lender uses the escrow funds to pay them. That way, you don’t have to keep up with the payment deadlines and you’re not forced to shell out hundreds or thousands of dollars all at once to cover your taxes or keep your insurance current.
How Escrow Accounts Benefit Homeowners
Convenience is arguably the best thing about using an escrow account. Having just one single payment to worry about each month means you don’t have to write multiple checks or chase down receipts for payments. If you live in a community that has a homeowner’s association, you can add these fees into the escrow account to streamline your monthly budget even further.
Lenders sometimes offer buyers an incentive for setting up escrow accounts – incentives such as lower mortgage interest rates. In the long run, that can make a significant difference in the cost of buying a home.
How Do I Set Up an Escrow Account?
Most mortgage lenders allow borrowers to set up escrow accounts to cover insurance premiums and property taxes. Each lender sets its own rules around such accounts. However, mortgage lenders must send you annual statements of your escrow account. These provide key details such as the money held in the account and the payments you’ve made.
Money required to be held in the account may change in time as insurance premiums and property tax assessments may rise or dip. In case of shortages in the account, the lender usually covers the difference before increasing your interest rate account for the difference.
Why You May Want to Skip Escrow
If you’re already getting a good deal on your mortgage rate, forgoing escrow may be a good idea. While some lenders are legally obligated to pay homeowners interest on the money in their escrow accounts, that’s not always the case. By investing the money you’d normally be putting in escrow into a CD, money market account or even a regular savings account, you could earn a bit of a return on your cash in the process.
Avoiding escrow could also be a good move if you want to be sure that your mortgage payments are the same from month to month. If you have an escrow account and your property tax bill or your insurance premiums suddenly jump, you might not be aware of the change until the end of the year.
Know When Escrow Is Required
Generally, an escrow account is a prerequisite if you’re not putting at least 20% down on a home. So unless you’re bringing a sizable chunk of cash to the closing table, escrow may be unavoidable. FHA loans, for example, always require buyers to set up escrow accounts.
Fortunately, you may be able to get rid of your escrow account down the line. Just be prepared to show proof that you’ve made on-time payments each month and built enough equity in your home. Otherwise, the lender may not agree to let you off the escrow hook.
Tips for Homeowners
- If you can’t secure a favorable interest rate on a conventional mortgage, you may want to consider a USDA loan or look into first-time homebuyer programs. These tend to provide reasonable rates for people with less than favorable credit scores.
- The home buying process can be a daunting task, and costs are of the utmost importance. So you may want to find a financial advisor who can help you manage your money the right way to cover all the costs associated with buying a home.
Photo credit: ©iStock.com/stellalevi, ©iStock.com/Predrag Vuckovic, ©iStock.com/kokouu