While Federal Housing Administration, or FHA, mortgages require an escrow account be established, homebuyers may have the choice in other instances of setting up an escrow account or paying taxes and insurance out of pocket if they put down at least 20 percent of the purchase price.
With an escrow account, the amount you owe in property taxes and homeowners insurance for the year is divided into 12 parts. Say your annual taxes are $3,000 and your insurance is $600. Your mortgage payment to your financial institution would include $300 each month to cover those costs.
Without an escrow account, you'd have to pay $3,600 out of pocket when your insurance and tax bills are due.
Here are some questions to consider if you're trying to determine whether to establish an escrow account.
Am I a good saver?
The first thing to ask yourself is whether you're a saver by nature. If not, you're better off having an escrow account, Mollica says. Being prepared to write a check for $3,000 to cover taxes and another for $600 to cover insurance is a daunting task.
If money burns a hole in your pocket, it may be tempting to use the money you set aside for taxes and insurance and take a pricey vacation instead.
But if you don't have the cash on hand when those bills come due, you might have to take a credit card cash advance. If you pay late, you'll be assessed a fee. "It's a whole lot cheaper to not have those mistakes," Mollica says.
Pat Hellman, Wells Fargo's senior vice president of mortgage servicing operations in Des Moines, Iowa, says escrow accounts also help homeowners with their budgeting as insurance and taxes fluctuate from year to year.
Wells Fargo has seen homeowners face property tax increases of up to 15 percent recently. If your property tax ends up being higher than anticipated, the additional payment will be stretched over 12 months rather than you having to pay it in one lump sum.
However, those who are self-employed or receive commissions -- thereby experiencing monthly income fluctuation -- have more flexibility if they pay for insurance and taxes directly, says Joe Chatham, president of Chatham Mortgage Partners Inc. in Westlake Village, Calif. They can set aside extra money in months when their earnings are strong.
Where else can I put my cash?
If you're good at saving money, Mollica says it doesn't make sense to make monthly payments for something you only need to pay once or twice a year. "It's free money for the banks," Mollica says.
If you don't like handing your money over to the bank each month and are wary of the vagaries of the stock market, then savings, money market accounts and certificates of deposit could be alternatives. Even if the rates are low today, the rates will go higher in the long term, Mollica says.