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, this 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 people were not always prepared to pay a large annual property tax payment.
What Is An Escrow Account?
Escrow accounts are actually pretty simple concepts, but there is a lot of confusion surrounding these accounts. There are some people who have owned a home for decades, but still don’t understand escrow accounts.
When you get a mortgage loan, the lender is going to add real estate taxes and insurance premiums to the monthly payment.
The lender is going to set this money aside into a separate account, and that’s your escrow account.
Money in the escrow account is used to pay your mortgage principal and interest, as well as your property taxes and your homeowner’s insurance premiums.
The real purpose of the escrow to ensure the lender won’t lose any money from tax liens.
Setting up an Escrow Account
There is a chance the lender didn’t require you to set up an escrow account when you got the loan. Not every lender requires one, but maybe you want to set up an escrow account to help budget your money for taxes and insurance.
Luckily, it’s easy to set up your own account.
Before you set up an account, you’ll need to decide how much money you’ll need to deposit into your escrow every month.
To do this, you need to get your annual homeowner’s insurance premiums, divide the number by twelve, and then add in your property taxes (also divided by twelve).
Once you’ve added those two numbers together, then this how much you will need to put into your escrow account every month.
After you’ve calculated how much you’ll need in the account, then you need to decide where to hold the account.
The best place to start is with the bank you already use. More than likely, your bank has an escrow agent that can help you set up an account.
If you bank doesn’t offer escrow services, then you can just do a simple search for “escrow company” and you will see dozens and dozens of different options.
To open the account, you’re going to need a lot of information.
They will need the:
- purchase price
- termite report
- financing information
- seller’s name
- and much more
Some banks and companies are going to require additional information. You should contact them beforehand to ensure that you have all of the documentation that you need.
After that, you can put the initial deposit into the account and set up automatic deposits that will put money into the account every month.
How An Escrow Service Works, Internally
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.
However, the 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.
The 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 $2,400 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, this 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.
While you can’t always avoid having an escrow account, there is a chance you can have your account canceled in the future.
In most cases, if you are borrowing more than 80% of the value of the home, then they are going to require you use an escrow account for the mortgage loan. After you’ve paid off enough of the loan, there is a chance you can get the escrow requirement waived, depending on the lender.
There can be some restrictions to canceling your escrow.
Some banks or lending companies require the mortgage loan is at least one-year-old, and has zero late payments.
Other companies are going to require there are no taxes or premiums due in the next month. Some companies are going to require a waiver fee when you cancel your escrow account.
If you want to cancel the account, contact your mortgage company and they can walk you through the process.
Hopefully, this post has cleared up any confusion that you have about escrow accounts and how they work. They aren’t as confusing or scary as they might seem. In fact, they can be a very valuable tool once you understand how they operate and the advantages of these accounts.
If you have any specific questions about your account, contact your lender and they can answer any issues that you have or clarify and questions that you still have.
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.