What is an escrow account? Pros and cons

An escrow account is a special account used to pay the annual property tax bill and homeowners insurance premiums.. However, instead of scheduling payments and paying these bills separately from a checking account (as is normally done with a utility account), the money is collected by the lender through installments as part of the regular monthly payment. the owner’s mortgage. The lender then uses the escrow money to pay taxes and homeowner’s insurance bills as they come due.

Some homeowners are required by their lenders to have an escrow account; others may choose whether or not to have an escrow account with their mortgage servicer.

What is an escrow account?

The key difference between an escrow account and any other financial account you may have is that you don’t manage it yourself.

That’s because custody or escrow is defined as a legal agreement with a neutral third party, where money is deposited under the terms of a contract. When it comes to your mortgage, the loan servicer acts as a neutral third party.

What are the advantages of an escrow account or escrow account?

It’s automatic

Keeping property tax and homeowner’s insurance payments in escrow ensures those bills are paid on time to avoid penalties, such as late fees or possible liens against your home.

You are covered when there are shortfalls

Your insurance premiums and property tax assessments will fluctuate over time. If your escrow account turns out to be insufficient due to an increase in your tax bill, for example, the collector will usually cover the difference on a temporary basis. However, they will most likely increase your monthly mortgage payment to make up the difference.

no surprises

The exact amount needed for escrow account payments added to your monthly mortgage payment. You will receive written notice from your lender when you are required to increase the escrow contributions to your monthly mortgage payment. In addition, your servicer must send you an annual escrow account statement showing the amounts you have paid and the withdrawals that have been made.

“Escrow accounts make life much easier for most homeowners who want the peace of mind of making monthly payments instead of twice-yearly large insurance and property tax bills” says Greg McBride, CFA, principal financial analyst at Bankrate.

Potentially lower mortgage costs

Depending on your lender, you may be able to get discounts on your interest rate or closing costs just for having an escrow account.

What are the disadvantages of an escrow account or escrow account?

It’s automatic

This advantage can become a disadvantage for people who know how to manage their money well. The mortgage servicer usually collects the amount of your payments, plus a reserve amount, month to month.

You may miss short-term investment opportunities

Money that ends up as surplus in an escrow account could be used for short-term investments. Earning interest on these investments makes more financial sense to many people than letting a bank or lender collect the proceeds.

However, heCreating an escrow account is a personal decision, and some homebuyers might prefer to have more of their liquid cash working for them outside of an escrow account, he says. Henry Yoshida, CFP, CEO of Rocket Dollar, a self-directed IRA and exclusive 401(k) provider based in Austin, Texas. Digital tools and attractive CD rates can help you invest your money outside of the box. escrow account for better long-term performance, he adds.

Examine current interest rates and your budget to determine if it’s right for you.

“With interest rates at the levels they are, there is limited opportunity cost of giving up interest earnings on money that is instead being deposited by the loan servicer throughout the year,” McBride says. .

A high down payment

Often, setting up an escrow account requires the owner to deposit an amount equal to several months of property taxes.

It can be hard to get rid of an escrow account

Once you have an escrow account with your lender, it’s hard to withdraw it later if you change your mind.

Escrow accounts can be attractive to scammers

The large sums that often accumulate in an escrow or escrow account make these accounts attractive targets for scammers. Cyber ​​thieves often create fake websites that look like the company you work for, or spoof email addresses trying to get your personal information. Some sophisticated scammers even set up fake phone lines in an attempt to build trust.

Can I avoid an escrow or escrow account?

Deciding whether to set up an escrow account with your lender or pay your property taxes and homeowner’s insurance on your own depends on your personal situation and financial habits.

Maintaining an escrow account may or may not be necessary, depending on the details of your mortgage. Many mortgage lenders allow homeowners to make property tax payments directly to the county assessor and homeowners insurance premium payments to your insurer.

But nevertheless, to qualify for this option, lenders generally require a loan-to-value ratio of less than 80 percent. That means you must have a down payment of at least 20 percent on your house.

When do I need an escrow account?

This is particularly true if you are receiving a loan insured by the Federal Housing Administration (FHA). FHA loans require escrow accounts.

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