Many times, buyers who are purchasing a home need to decide whether they need or should setup a mortgage escrow account when they close on their new home. The purpose of a mortgage escrow account is to allow the mortgage company to pay the homeowners property taxes and homeowners insurance premiums when due. These premium amounts are included in the homeowners’ monthly mortgage payments. A buyer who is putting down less than 20% usually has no choice but to have an escrow account due to lender requirement. Most lenders require a buyer to have an escrow account until buyer has at least 20% equity in the property when financing using a conventional loan. Also, one main difference between an escrow account versus non-escrow account, a third party manages the account usually a mortgage lender or servicer.
Now let us address the pros and cons of having an escrow account:
Automatic – Your mortgage company or the servicer of the loan will automatically pay your property insurance and taxes on time from your escrow account. Having this done, avoids penalties due to late payments or potential liens that might me placed against your home.
Insurance and property tax shortfalls – Your property insurance premiums and property tax amounts owe will fluctuate over time. In either case if your escrow account does not have sufficient funds your servicer will cover the shortfall amount. Normally, you will receive a letter from the servicer offering couple options how to adjust mortgage payment to cover the shortfall amounts moving forward.
No surprises majority of the time – Your annual property taxes and insurance premium are pro-rate monthly and added to mortgage plus interest amounts to develop your total monthly mortgage payment. Your lender or servicer is required annually to send you an escrow statement showing all amounts paid along with any overages or shortages. Having an escrow account makes it easier for homeowner to control their monthly expenses.
Funds to better use – While it is nice for the homeowner not to have to think about making their property tax and insurance payments, they may have been able to put their funds to better use. It is possible, you may be able to invest in short-term investments. This allows the homeowner to make additional money instead the financial institution using your funds to make more money for themselves. Before making a final decision be sure to analysis your own budget and current interest rates.
Prepaid expenses – When a homeowner uses an escrow, he will be required to deposit at closing an amount equal to several months of property tax and insurance premiums. This is referred to as prepaids. This can be a significant amount required from the buyer.
Get rid of escrow – Once you have an escrow account it takes a lot of effort to rid yourself of this account. If you have an FHA loan you are required to have an escrow account and mortgage insurance for the life of the loan. Here you would need to refinance using another loan type to rid yourself of this requirement. A conventional loan normally requires at least 20% equity in home before you can rid yourself of escrow account and mortgage insurance.
Scammers – Large amounts of money setting in escrow accounts can be attractive to scammers. Cyber thieves tend to setup fake wed sites like the servicer web site trying to get your personal information or set up fake phone lines to build up trust.
In conclusion, escrow accounts may or may not be required depending on the type of loan and the lender. If you do not have an escrow account as a homeowner, you will be required to pay your property taxes directly to county assessor and homeowners’ insurance to their insurer. The escrow account is a common tool used by lenders to make it easier to meet your financial obligation. If you do not have an escrow account, you may want to explore alternative ways to invest these funds, so you have the funds available when needed.