Should You Use an Escrow Account To Pay Your Home Insurance?
Homebuyers are on the hook for many expenses that go beyond their monthly mortgage payment. On top of paying their loan, most are also responsible for covering property taxes and homeowners insurance premiums. The latter may come due on a monthly basis or in larger chunks periodically throughout the year, depending on your insurer.
It’s an unavoidable expense for the majority of homeowners, but taking care of it with an escrow account can automate your payments and make life a little easier. Here’s a simple breakdown of how escrow accounts work when it comes to paying your homeowners insurance premiums.
What Is a Mortgage Escrow Account?
Unlike a regular checking or savings account that you open and manage on your own, an escrow account is set up and managed by mortgage lenders and servicers, typically during the homebuying process. This separate account is set aside to pay additional non-mortgage expenses like property taxes and homeowners insurance premiums. Instead of making these payments yourself throughout the year, the amount is added to your monthly mortgage and then directed to your escrow account. From there, the mortgage servicer draws on that account to pay these bills on your behalf.
Think of it as a holding space for your homeowners insurance premiums. An escrow account allows you to take care of this obligation with virtually no effort on your part. Instead, the mortgage servicer sends your payment to your insurer for you. The same account can also be used to pay your property taxes to your county assessor. (Pretty simple, right?) From there, your mortgage servicer will provide annual account statements so that you understand your escrow account’s balance and transaction history.
Not every homeowner needs to use an escrow account. Some may have the option to pay their property taxes and homeowners insurance themselves. However, most mortgage servicers require an escrow account for borrowers whose down payment is less than 20 percent. It’s also a non-negotiable for federally backed FHA loans and USDA loans. Similarly, if you’re an existing homeowner who’s refinancing their mortgage, you’ll likely need to have at least 20 percent equity in the home for the lender to waive the escrow requirement. Having an escrow account is reassuring to mortgage servicers as it helps ensure that your homeowners insurance premiums will indeed get paid.
How To Set Up an Escrow Account
An escrow account is a relatively hands-off financial tool that’s typically opened and managed by mortgage servicers, usually when a loan is being originated. This generally involves the homebuyer putting up a sizable chunk of funds that are wrapped into their closing costs to pad the escrow account from the get-go. Doing so provides a cushion and ensures that they’ll have funds to draw on when the time comes to pay your insurer on your behalf.
Pros and Cons of Paying Your Homeowners Insurance Through Escrow
Like anything else, there are pros and cons to paying your homeowners insurance through an escrow account. Below are some important points to consider.
The Convenience Factor. If you’re a set-it-and-forget-it type of person, you may like the convenience and peace of mind that an escrow account provides. To cover your homeowners insurance premiums and property taxes on your own, you’ll have to keep track of due dates as they arise throughout the year. This puts the onus on you to set that money aside each month in a safe place where you won’t be tempted to spend it. Using an escrow account takes care of this obligation for you.
The mortgage servicer adds the amount directly to your monthly loan payment and takes care of the rest. Escrow accounts also free up time since you won’t have to communicate with your insurer or tax assessor to pay your bills.
Your Mortgage Servicer May Incentivize Escrow Accounts. Again, escrow accounts are attractive to mortgage lenders and servicers because they help ensure that your homeowners insurance and property taxes will get paid on time. To that end, some incentivize escrow accounts to make them more attractive to homeowners. This may include a break on closing costs or a lower mortgage rate. The latter is a biggie that could save you thousands over the life of your loan. Even if you aren’t required to use an escrow account, this incentive alone could make it worth your while.
Your Closing Costs Will Likely Be Much Higher. When opening an escrow account during the homebuying process, you can expect significantly higher closing costs since the mortgage lender needs to fund the account. This could translate to thousands of extra dollars due at closing — that’s on top of your down payment and other lender fees that may apply. As mentioned earlier, you may not have a choice in the matter if you’re putting down less than 20 percent, but it’s an important thing to remember when budgeting for your new home.
You May be Missing Out on Investment Opportunities. When your mortgage servicer is managing your escrow account, they may charge you a little more than what your actual homeowners insurance and property tax bills end up totaling. This is because your insurance premiums could go up or down and mortgage servicers don’t want to come up short. Similarly, your tax bill could also fluctuate following an assessment. In the event that there isn’t enough in your escrow account to cover these obligations, most mortgage servicers will step in and cover the gap, then charge you the difference later.
On the flipside, you could end up having excess money in your escrow account going unused. Some may argue that you could put that money to better use by investing it elsewhere, like adding it to a retirement account or high-yield savings account. This type of investment return is never a guarantee, but it might make more sense than having that overflow just sitting in an escrow account.
Determining if an Escrow Account Is Right for You
Those who have less than 20 percent equity in their home will likely be required to use an escrow account. Homeowners who are above that threshold typically have more flexibility here. It really comes down to your personality and saving style. If you like the idea of having your mortgage servicer take care of your homeowners insurance premiums and property taxes for you, then the convenience of an escrow account may grab your attention. The same goes for folks who think it might be difficult to set that money aside on their own each month.
The Final Word on Escrow Accounts
Escrow accounts can provide peace of mind and convenience as they reduce the burden of having to pay your homeowners insurance premiums and property taxes yourself. Another benefit is that you can still shop around with different insurers whenever you like and save money by changing your policy. Just be sure to loop in your mortgage servicer so they can direct your payments accordingly.
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