If you’re buying a home, you may be curious as to why escrow accounts are such a common part of the process. As a homeowner, your home is likely one of your biggest assets, if not the most important, and it’s important to protect it with the right homeowners insurance policy. If something happens to your house and it’s uninsured, you may not be able to recover financially. That’s where home insurance escrow accounts come in.

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An escrow account is designed to ensure that policyholders have enough funds to cover their home insurance premiums, and that the payments are made on time. This ensures that the homeowners policy stays active on the home. Not every homeowner is required to use an escrow account, though. If your lender allows you to opt out of using an escrow account, you may be considering whether to use one. Before you make a decision, though, it may be helpful to understand why an escrow account is established and what the pros and cons are of having one.

What is a homeowners insurance escrow account?

A homeowners insurance escrow account is a separate bank account your mortgage lender maintains. The account is specifically designed to house money you set aside each month to pay for several key mortgage items, including homeowners insurance. Then, when the lump sum for your homeowners insurance bill is due, the amount is withdrawn from this separate bank account.

The escrow account can also be used for property taxes and mortgage insurance, in addition to homeowners insurance. When you make a payment each month to your mortgage lender, it typically includes both your mortgage and your escrow account payment. Then, depending on how your account is set up, your mortgage lender makes the payment on your behalf when the lump sum is due.

How does an escrow account pay for homeowners insurance?

Before closing on a home, you will want to verify if your lender is required to set up an escrow on your behalf or if you have the option to handle it yourself. If your lender is responsible for setting up the escrow account, you will need to pay attention to any documents related to escrow during the closing process. Once the lender or bank sets up the escrow account, you will pay towards it each month when you make your mortgage payment.

Homeowners insurance premiums are quoted for one year. Because the lender requires you to carry insurance for your property, the escrow account is established to ensure the payment is made. The amount you are quoted for annually is divided up into 12 equal payments, which is the amount established for monthly payments. When you close on your property, the first year of premiums is typically included in the closing costs.

For example, if your homeowners insurance premiums are $1,000 annually, the payment will be $83 per month and added into the escrow account. Keep in mind that while your homeowners insurance premium could increase or decrease, it may not change your total monthly payment each month. It is possible your taxes or mortgage payments could also change, which might offset any changes to your homeowners insurance premiums.

Pros and cons of paying homeowners insurance with an escrow account

There are a few upsides and potential downsides of paying your homeowners insurance with an escrow account. While some homeowners like knowing the annual bill can be taken care of without much hassle, other homeowners might want to take on the responsibility of making annual payments themselves.

Pros Cons
When the homeowners insurance bill is due, the money should already be set aside to cover it as long as you have kept up on payments. There is a larger upfront payment with closing costs, since you are generally required to prepay homeowners insurance.
Because your mortgage lender handles the payment for you, it’s one less task to remember. You potentially miss out on short-term investment opportunities by not saving the money in your own account.
Some states allow you to earn interest from the escrow account. There are higher monthly mortgage payments with no option to alter the payment if your budget is tight that month.
Homeowners insurance becomes an automatic payment with no surprises when the bill is due.

Keep in mind, the type of loan you have and the state you live in may require you to have an escrow account. However, if you have a choice, you should consider if the pros outweigh the cons for you and if you are disciplined enough to set aside the money for the annual payment or monthly payments yourself. Some homeowners prefer to keep the money in their own account so they can control how the money is saved or invested.

Should you keep your home insurance after paying off your mortgage?

Once your mortgage is paid off, you will face the question of whether you should maintain a homeowners insurance policy since homeowners insurance is not a legal requirement. Before giving up the policy, remember that homeowners insurance can help you avoid financially devastating out-of-pocket costs should your property be damaged or destroyed by a covered loss.

Your property is likely to be your most valuable asset and homeowners insurance can help you financially protect it when covered damage or loss occurs to the structure. Additionally, it also covers your personal belongings inside your property. If someone gets hurt while on your property, you will have peace of mind knowing the personal liability coverage from your policy can help pay for their medical expenses and help you defend yourself in court if needed. Some of the expenses associated with medical bills or repairs to the home can be quite costly. A proper homeowners insurance policy could help keep your out-of-pocket costs to a minimum and keep you from facing exceptionally large medical or construction costs. Plenty of affordable home insurance companies are also available.

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