Man reviewing escrow paperwork
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An escrow account is a special holding account that enables homeowners to pay their annual property tax bill and homeowners insurance premiums in installments in their regular monthly mortgage payment.

Instead of paying those bills separately, many homeowners opt for or are required to have an escrow account with their lender, which collects these payments on a monthly basis.

Holding your property tax and homeowners insurance payments in escrow ensures that those bills are paid on time to avoid penalties such as late fees or potential liens against your home.

How escrow accounts are managed

An escrow account is managed by a mortgage servicer. The amount of money in the account can change from year to year because insurance premiums and property tax assessments tend to fluctuate over time. If there are any shortfalls in the escrow account, the lender typically covers them temporarily and eventually increases your monthly mortgage payment to make up the difference. You’ll get a notice from your lender in writing when this happens. The servicer is required to send you an escrow statement annually that shows the amounts you’ve paid and the drawdowns, plus any overages or shortages.

Can I avoid an escrow account?

Maintaining an escrow account may or may not be required. Many mortgage lenders allow homeowners to make property tax payments directly to the county assessor and homeowners insurance premium payments to their insurer. In order to have this option, though, lenders generally require a loan-to-value ratio below 80 percent. That means you’ve put a down payment of at least 20 percent on your home.

If you get a loan insured by the Federal Housing Administration, or FHA, however, you won’t have the option to pay these bills separately. FHA loans require escrow accounts.

Generally speaking, once you’ve set up an escrow account with your lender, it’s difficult to remove it later, and vice versa.

If you opt to forgo an escrow account and fall behind on tax or homeowners insurance payments, you could face significant penalties and late fees. You could lose your homeowners insurance coverage, and the tax assessor can put a lien against your property if you miss payments.

“Escrow accounts make life a lot easier for the majority of homeowners that want to add predictability to their monthly expenses rather than getting whacked twice a year with big (homeowners) insurance and property tax bills,” says Greg McBride, CFA, Bankrate’s chief financial analyst.

Do I need an escrow account?

Deciding whether to set up an escrow account with your lender or pay your property taxes and homeowners insurance on your own depends on your personal situation and financial habits. Here are some considerations to think about as you weigh the decision.

1. Savers

People religiously stick to a monthly budget and are good at saving money regularly could skip an escrow account.

While property tax bills are paid annually, homeowners insurance premiums are can be paid monthly, annually or even semi-annually, so you’ll need to be on top of making those payments.

Having an escrow account in place can help homeowners better manage their money and budget for other bills.

2. Other investments

Another reason some forgo an escrow account is because they want to invest their cash in short-term investments, such as CDs and money market accounts.

Earning interest on such investments makes more financial sense to many people instead of allowing a bank or lender to reap the gains.

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

Examine the current interest rates and your budget to determine whether it makes sense for you.

“With interest rates where they are, there is limited opportunity cost from forgoing interest earnings on money that is instead being escrowed by the loan servicer throughout the year,” McBride says.

3. Responsibility shifts

When an escrow account is created, the responsibility of paying the bills on time lies with the lender and not you.

This could be helpful if your property taxes are divided into school taxes, water and sewer district, and a general county fund. An escrow account would pay all of those different entities on time.

Being late on your property taxes can cost you additional money in late fees and penalties. The tax collector could put a lien on your home for falling behind on your property tax bill, and that could pose a challenge if you want to sell your house soon.

Skipping payments on your homeowners insurance might result in your coverage being dropped, and that could be costly if you have to use your own savings to pay for damages your policy would normally cover.

Bottom line

Deciding whether to have an escrow account is a long-term decision. Review each option carefully, and factor in your financial situation and discipline to pay bills as you make your choice.

“Can disciplined, savvy homeowners come out ahead by eschewing the escrow account and just paying the bills on their own when they come due?” McBride says. “Sure, but they’re the exception rather than the rule.”

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