When purchasing a home with a reputable lender, an escrow account will be set up for you as well. Once the account is established, the lender will collect the money from you on a monthly basis for property taxes and homeowner’s insurance, hold it in the escrow account and then pay those bills on your behalf when they come due. This can be a great benefit to buyers, as payments are made on a monthly basis for bills that are due semi-annually or annually.
How does an escrow account work?
When establishing an escrow account, your lender will calculate the total annual payments for your property taxes and homeowner’s insurance. The annual amount will then be divided by 12 to calculate your monthly escrow payment and added to your principal and interest payment to make your total mortgage payment. Additionally, most lenders require a cushion of two months of escrow payments in the account.
Every year, your lender will review your escrow account to ensure it has sufficient funds and recalculate your payments based on the previous year’s property tax and insurance costs. If there is a shortage within your account, your lender will require you to make a one-time payment to cover the deficit or increase your mortgage payment the following year. If there is an overage in your account, your lender will give you a check for that amount and may decrease your escrow payment for next year.
Advantages of Escrow Accounts
Budgeting is simpler because you do not have to think about setting aside money to make your annual or semi-annual property tax and homeowner’s insurance payments. Including these with your mortgage payment will ensure your property tax and insurance payment are covered without penalties.
Disadvantages of Escrow Accounts
When closing on your home mortgage, you will typically need to produce more money to establish the buffer of two months of payments in your escrow account. That amount may be larger, depending on when your property tax and homeowner’s insurance payments are due. Plus, your monthly mortgage payment is higher when you have to make a payment into an escrow account in addition to your regular principal and interest payment.
Avoiding an Escrow Account
If you prefer to not have an escrow account, you will need to negotiate it with your lender. The lender might be willing to allow you to manage your property taxes and homeowner’s insurance payments rather than using an escrow account. Typically, you’ll need to have put at least 20% down on your home, be a prior homeowner or have a large cushion in your bank account. If you choose to forego the escrow account, you should budget carefully to ensure you have the money available to make your property tax and homeowner’s insurance payments when they are due.
Paula Medrano is a senior mortgage loan originator with Independent Financial and specializes in helping new buyers achieve home ownership. Connect with Paula at 972.350.8361 or Paula.Medrano@IFinancial.com.
