The Bankrate promise
At Bankrate we strive to help you make smarter financial decisions. While we adhere to strict , this post may contain references to products from our partners. Here's an explanation for .
A mortgage escrow account is an integral part of the financial picture for many homeowners.
Mortgage escrow accounts are typically used in two ways: to hold an earnest money deposit a buyer puts on a home after signing a contract with the seller (it’s released at the closing), and to pay a homeowner’s property taxes, mortgage insurance and homeowners insurance premiums.
When it comes to the latter, some homebuyers are required by their mortgage lender to have an escrow account; others may opt-in to one through their mortgage servicer. If you do have a choice, here are the pros and cons of mortgage escrow accounts.
What is a mortgage escrow account?
Once you become a homeowner, a mortgage escrow account is an account used to hold and ensure that some of the major, ongoing expenses associated with your home are paid on time. Typically these expenses include:
- Mortgage insurance payments
- Homeowners insurance premiums
- Property taxes
Instead of paying insurance and taxes separately from a checking account, the money to cover these bills — plus a little extra, a “cushion” — is included in your total monthly mortgage payment. The mortgage lender or servicer holds these funds in an escrow account and makes the payments as they are due on the homeowner’s behalf. It might be monthly, quarterly or bi-annually.
The key difference between an escrow account and any other financial account you might have: You don’t manage an escrow account yourself. That’s because “escrow” is facilitated by a third party — in this case, your lender or servicer.
Should you use an escrow account?
First of all, depending on the type of loan and its specifics, you might not have the option to forgo an escrow account. If you’re obtaining a conventional mortgage — that is, one from a private bank or lender — an escrow account is often required if you’re making a down payment of less than the standard 20 percent, as is mortgage insurance. If you’re getting a federally backed loan, you often don’t have a choice either. FHA loans and USDA loans require escrow accounts, though VA loans do not.
Let’s assume you do have a choice. There are viable reasons to have an escrow account: It can be an easy, hassle-free way to make payments for your mortgage, homeowners and mortgage insurance and property taxes, and the cushion can help cover shortfalls. Although you’ll have a higher monthly mortgage payment, consider what it’d take for you to make those payments on your own several times a year: You’d need to be diligent about setting aside the funds, including extra for any unforeseen increases in premiums or taxes, and then making sure you meet the due dates for payments.
Pros of an escrow account
Having your mortgage lender or servicer hold your property tax and homeowners insurance payments in escrow ensures that those bills are paid on time, automatically. In turn, you avoid penalties such as late fees or potential liens against your home.
You’re covered when there are shortfalls
Your homeowners insurance premiums and property tax assessments can fluctuate over time. For example, if your escrow account happens to be short due to your property tax bill increasing, your servicer will typically cover the difference temporarily. To make up for it, they’ll eventually increase your monthly mortgage payment.
The exact amount needed for escrow is added to your monthly mortgage payment for you, so you’ll know what to expect the majority of the time. If the escrow component of your monthly mortgage payment needs to increase, you’ll get a notice from your lender or servicer in writing. Plus, your lender or servicer is required to send you an annual escrow statement that shows the amounts you’ve paid (and the drawdowns) along with any overages or shortages.
“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 insurance and property tax bills,” says Greg McBride, CFA, Bankrate’s chief financial analyst.
Potentially lower mortgage costs
Depending on your mortgage lender, you may be able to get a discount on your interest rate or closing costs just by having an escrow account.
Cons of an escrow account
While it’s nice to not have to think about making various insurance and tax payments, this pro can be a con for organized homeowners who prefer to have full control over their payments. Many mortgage lenders allow homeowners to make property tax payments directly to the county assessor and homeowners insurance premium payments to their insurer.
You might miss out on short-term investment opportunities
In particular, the money that could end up as an overage in an escrow account could be used for short-term investments. Earning interest on such investments may make more financial sense for you, instead of allowing a bank or lender to reap the gains.
Digital tools and attractive CD rates can help you invest your money outside of escrow and earn a better return for the long term, notes Henry Yoshida, CFP, founder and CEO of Rocket Dollar, a platform based in Austin, Texas, that enables users to invest funds from tax-advantaged retirement accounts.
“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.
A large upfront deposit
Often, setting up an escrow account requires a homebuyer to deposit an amount equal to two to three months’ worth of property taxes and insurance premiums. These are sometimes called “prepaids,” and can significantly add to your mortgage closing costs.
Because you’ll be paying for insurance and taxes with your regular mortgage payment, you’ll have a higher payment each month. Of course, you have to pay for insurance and taxes inevitably, so they aren’t an additional cost, but having them in your monthly payment could leave less room in your budget month to month.
Can be a target for scammers
The large sums parked in an escrow account make it an attractive target for fraudsters. Common mortgage escrow fraud schemes include cyber thieves setting up fake websites that look similar to the servicer you’re working with, or spoof email addresses to try to get your personal information. Some sophisticated scammers even set up fake phone lines in an attempt to build trust. Under these false pretenses, fraudsters might try to persuade you to wire them money.
Possibility of incorrect estimates
The amount that needs to be tucked away in your escrow account hinges on your insurance premiums and property taxes, which can vary year to year. Generally, the previous year’s bills are used to figure out how much you’ll need, but incorrect estimates can happen if, for example, the assessed value of your home has increased — or you appeal and get a reduction in your property taxes.
Bottom line on mortgage escrow accounts
With a mortgage escrow account, your mortgage lender or servicer is allowed to collect the amount of your homeowners insurance, mortgage insurance and property tax payments, plus a cushion, month in and month out.
Ultimately, an escrow account is a common financial tool lenders and servicers use, helping to ensure your obligations as a homeowner are met without much effort on your part (aside from making your mortgage payment). It can be convenient for you, too. However, if escrow isn’t required, you might want to explore alternative uses for those funds.