What Does It Mean To Escrow Taxes And Insurance?

To Escrow or Not to Escrow? That is the Question.

The financial responsibility of a homeowner — in Urbandale and everywhere else — extends beyond the mortgage’s basic principal and interest repayments. Homeowners are also always responsible for the real estate taxes on the home and its insurance premiums as well.

The not-so-good news is that failure to pay taxes can lead to foreclosure, and failure to insure the property is breach of your mortgage contract. Seriously, they’ll force place insurance on your property (which isn’t cheap!) if you don’t keep your own. They’re very serious about this.

As a homeowner, you have a choice about how you manage your real estate tax and insurance bills. You can choose to pay them from your own bank account when the bills come due, or you can choose to pay 1/12 of the annual bill to your mortgage servicer each month, and then let your servicer pay the bills on your behalf when they come due.

Not surprisingly, servicers prefer the latter method — it reduces two major lender risks:

That the home’s real estate taxes go delinquent and are sold to a third-party
That the home endures catastrophic damage during a lapse of insurance coverage

In theory, when the servicer is paying the bills, the home’s taxes are always current and the home’s insurance is always paid. This method of managing taxes and insurance is commonly called “escrowing”.

How is Your Escrow Payment Calculated?

To calculate a home’s monthly escrow payment is simple. Just take the sum of the annual real estate tax bills and insurance bill, then divide it by 12 months in the year.

As a example, a $4,000 annual tax bill with a $800 insurance policy = $4,800 annually = $400 paid into escrow monthly. These monies are collected as part of the regular mortgage payment along with the mortgage’s scheduled principal + interest payment.

Homeowners choosing to escrow generally get the lowest rate and lowest fee loans. This is because lenders often charge a premium to “waive escrow” (i.e. clients paying their own taxes and insurance). Escrow waiver fees vary between banks/lenders, but can range up to half-percent of the amount borrowed. The larger the loan, the stiffer the penalty in dollar terms. Some mortgage professionals never even explain the pros and cons to clients.

Choosing to waive escrow can also raise your mortgage rate by up to 0.250 percent.

If you’re unsure whether escrowing is right for you, give me a call and/or a financial planner. There’s good reason to go either route depending on your profile.

Whatever you do, at least collect the facts and then make a decision. You may be surprised the cost involved to pay your own taxes and insurance.