An escrow is a legal arrangement with a neutral third party where money or goods are deposited until a contract is legally satisfied. In layman’s terms, that means an escrow service is basically a middleman between a buyer and a seller, or in the case of a mortgage, a middleman between a homeowner and the county (for property taxes), insurance companies, and anyone else who the homeowner designates to pay with funds from the escrow account.
Mortgage escrow accounts are very popular for mortgages and in many cases mandatory. Mortgage escrow services first became popular as a means to decrease the number of foreclosures due to people not paying property taxes. The problem was that people were not always prepared to pay a large annual property tax payment.
How an escrow service works
A mortgage escrow service is much like a forced savings account. Money is paid directly to the escrow service where it is held until payments are due. For example, when you pay your mortgage bill, several hundred dollars per month are added to your payment. That money doesn’t go toward your interest payments or principle. This money is set aside in your escrow account and used to pay your annual or biannual property taxes, homeowner’s insurance, and other bills.
Advantages and disadvantages of a mortgage escrow service
The biggest advantage of using an escrow service is not having to come up with large payments once a year to pay your bills. It is much easier for most people to pay $200 per month into a forced savings account instead of paying $2400 at once. Mortgage escrow accounts also guarantee your bills are paid on-time. Your payments have already been budgeted for you and the money is waiting and available in your account. When the bill is due, the escrow account takes care of everything for you. It is nice not to have to remember payment dates, amounts, etc.
There are advantages to the lender and county as well. The lender is assured your insurance premiums will always be up to date, so their asset (your house) is protected in the event of destruction. The county is assured they receive their property tax payments on time.
There are disadvantages though – most escrow accounts do not earn the account holder interest, though some earn interest at a low rate. For someone with a large house and a $10,000 property tax bill, that adds up to a lot of lost opportunity every year. There are also associated fees which cut into your bottom line.
Can you avoid using an escrow service?
Yes, but not always. Some mortgages require escrow accounts, especially for first time home buyers or home buyers with small down payments. There are some advantages for going without an escrow service – your money can earn you interest and you may be eligible for early payment discounts for some bills. But the disadvantages are obvious – you are required to pay your tax bills and insurance payments on time or risk losing your house.
A mortgage escrow account is an easy and simple way to manage your annual tax and insurance payments and put them on autopilot. Sure, it costs a little extra money every month, but to me, it is well worth the convenience.