Mortgage Escrow Accounts Explained



If you’re currently paying a mortgage on your home, odds are you’re paying your property taxes and homeowner’s insurance through a mortgage escrow account.  But what is a escrow account and is it really necessary?

A mortgage escrow account is kind of like a forced savings account.  When you make your monthly mortgage payment, you’re not only paying for the principal and interest on your home loan, you’re also paying a one-twelfth of your property taxes and home insurance premiums.

Your lender holds onto the funds in an escrow account and submits payment each time a property tax or insurance bill comes due.

Lenders obviously love when you use an escrow account because they’re holding onto your money.  When the time comes to pay the bills the money has already been set aside, so they don’t have to worry about payments being missed.

This is why most lenders encourage you to use an escrow account.  In fact they’ll probably go ahead and set you up with one unless you specifically request otherwise.   You can always ask your lender to waive the escrow requirement but some lenders make it mandatory, especially if it is you are a first time homebuyer or if you aren’t putting much money down.

Some lenders will charge you a fee in exchange for waiving escrow, so be sure to ask about that.

Pros and Cons of Mortgage Escrow Accounts

When I bought my first home I thought an escrow account made sense and so I didn’t even inquire if it was mandatory.  I do know they never asked me if I actually wanted it.

I didn’t mind it at first.  But then one day I opened the mailbox and pulled out the dreaded escrow analysis letter which informed me that I hadn’t been paying enough money into escrow and now there was a shortage.  My lender was kind enough to give me the choice of paying a lump sum of $2,200 or increasing my monthly payment by almost $200 a month.  That’s like being asked to choose between a kick to the teeth or a kick in the balls.

The account was short because they had used the prior year’s property tax assessment and because the timing of the payments meant that at one point there wasn’t enough to cover a payment so they were actually negative for a month.

Needless to say I wasn’t happy about funding the escrow shortage, but what made it even worse is that I got the same letter every year we lived in that house!   Future shortages were nowhere near $2,000 (more like $500 on average) but with property taxes rising every year there always seemed to be a shortage.  I came to dread the annual arrival of our escrow analysis letter.

Goodbye Escrow!

After almost nine years in our first home we decided it was time to start looking for another house.  We had gone from newlyweds with plenty of room to a family of five in a house that was bursting at the seams.  We also wanted to move to a town with a better school system.

When I started shopping around for a mortgage, the first decision I made was that I wanted nothing to do with escrow.  I’d much rather take care of my own property taxes and insurance and not deal with the aggravation that escrow gave me.

Not all lenders will agree to waive the escrow requirement and some will actually charge you a fee to waive it, which is ridiculous.  But my credit union didn’t give me any problems at all.

It does take a little more discipline to forego escrow.  You have to remember to actually pay the bills yourself (my property taxes are paid quarterly) and you have to make sure you’re putting money aside to pay them too!

What I did was set up a new sub-account in my Capital One 360 savings account and labeled it Property Taxes and Insurance.  I calculated how much I needed to put aside each month by dividing those expenses by twelve.  I actually save slightly more than that just so I have a little cushion when the taxes go up again (they never go down do they!)

When the bills come due I already have the money set aside to pay them, I never have to worry about escrow shortages.   Best of all, I actually get to earn interest on the money while it sits in my Capital 360 account!

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Mike is a freelance writer and blogger who specializes in finance and parenting topics. He is a dedicated husband and father of three who is obsessed with creating multiple streams of income and building wealth so he can achieve true financial freedom for his family. Like what you're reading? Subscribe to our free RSS feed and follow us on Twitter.

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Comments

  1. Mike, thanks for writing this. As a first time buyer, I don’t remember my lender ever giving me an option or explaining how this works.

    • I’m not surprised. They’d rather you use escrow so they have more control. I know it was never thoroughly explained to me when I bought my first home either. Some lenders will actually charge a fee to waive escrow, and others don’t offer that option at all, so it pays to ask around when you first start looking for a mortgage.

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