Escrowing Versus Paying Taxes and Insurance Yourself

Before analyzing the topic at hand, let’s first review exactly what escrow is. As defined by the web site Investopedia, it is: “A financial instrument held by a third party on behalf of the other two parties in a transaction.” In other words an escrow account holds funds by a third party such as an attorney or financial institution until the appropriate written or oral instructions or obligations have been fulfilled.

An escrow account is often used in a home sale transaction. When there are contingencies on the sale or mitigating factors such as passing a home inspection or researching titles and liens, the buyer and seller will agree to use an escrow account. It works so that the prospective buyer deposits an agreed upon amount in the escrow account which is in turn held by a third party. This action serves to assure the seller that the future buyer is capable of meeting the financial requirements to purchase the property. After all of the conditions are met, the escrow funds are then transferred to the seller and the title is transferred to the buyer.

Another type of escrow is a mortgage escrow account. With this type of account, you must pay the lender a certain amount each month in order to cover property taxes, homeowners insurance, and private mortgage insurance (PMI). The payment is included as part of your monthly mortgage. Collectively these are referred to as “escrow items.” In essence, the lender pays for those items on your behalf as the bills become due. Many home buyers like this arrangement because it ensures that the taxes and insurance premiums are paid on time and in full. It breaks down to approximately one twelfth of the estimated annual monthly cost of taxes and insurance within the total mortgage payment.

Some home buyers question their ability to handle such payments on their own and prefer to be in control of their funds. However, keep in mind that many lenders require an escrow account for certain types of loans, such as an FHA loan. In the case of a conventional loan, a lender will decide whether or not to require an escrow account. A good rule of thumb is that borrowers taking out a loan of more than 80 percent of the property’s value may be required to establish an escrow account. On the flip side, if you make a down payment of 20 percent or more, your lender may waive the escrow requirement if you prefer. Please do be aware that there are often fees required to waive the escrow process.

The logic behind this practice is that homeowners who have built up equity will realize that it is in their own best interests to pay the taxes and insurance premiums. A lender has the option of revoking the waiver when the homeowner becomes delinquent on the taxes and insurance.

It is also possible to cancel an escrow account. Each lender has their own set of guidelines for these procedures. Some may allow you to delete your escrow account if you hold a conventional loan and do not have PMI. However, this will depend on the terms of your loan agreement and state laws. For those with a conventional loan with PMI, an escrow account is required. The account also remains in effect until the PMI is no longer required.

Another scenario is that the home loan or mortgage must be at least a year old and had zero late payments. Yet another requirement may require that there is nothing due in the way of taxes or insurance premiums within the next 30 days.

Many homeowners like the idea of having fewer bills to worry about and prefer the auto-pay nature of a mortgage escrow account. Others like to account for every nickel and choose to handle this on their own. The idea of being able to earn more interest by keeping the funds to themselves and increase their tax deductions may appeal to many home buyers with mortgage escrow accounts through a lender. There is also the question of banking errors that would be less likely when the matter is managed by the homeowner.

However, others feel that the convenience of having these payments handled by their lender is priceless!