Should You Escrow Property Taxes and Insurance?

When buying a new home, you’ll likely wonder whether you should escrow your property taxes and insurance. With an escrow account, your monthly mortgage payment includes a portion of your estimated tax and insurance expenses. Your mortgage servicer draws from those funds when covered expenses become due. Some mortgages require borrowers to maintain escrow accounts, while others may allow them to pay these costs directly.

A financial advisor can help you develop a budget that takes into account the costs associated with buying a home.

What Is an Escrow?

Mortgage escrow provides a way to budget for recurring costs tied to homeownership. Under escrow, you don’t pay the entire property tax or homeowners insurance bill when it arrives. Instead, you contribute toward those expenses throughout the year as part of your mortgage payment.

At closing, a lender may collect an initial escrow deposit. For mortgages subject to federal escrow rules, that amount generally equals one-sixth of the estimated yearly escrow expenses. ¹ This covers roughly two months of escrow payments.

Afterward, part of each mortgage payment deposits into the account. The servicer uses those funds to pay expenses such as property taxes and insurance when they become due. The amount collected is based on expected bills and can change when those costs increase or decrease.

How Escrow Accounts Benefit Homeowners

Convenience is one potential advantage of using an escrow account. Property taxes and insurance premiums can involve sizable payments that come due only a few times a year. Escrow divides those anticipated expenses into smaller amounts collected with your regular mortgage payment.

Escrow can also reduce the risk of forgetting a tax or insurance payment. That can benefit both the homeowner and lender. Delinquent property taxes can result in a lien. And insurance gaps can leave the property without the coverage required under the mortgage.

Homeowners association dues, however, are generally separate from mortgage escrow. Homeowners typically remain responsible for paying those charges directly to their association.

How Do I Set Up an Escrow Account?

When escrow applies to a mortgage, the account is commonly established as part of originating the loan. The mortgage lender or servicer estimates the expenses and calculates the monthly amount needed to fund those bills.

For mortgages covered by federal escrow requirements, servicers generally may collect one-twelfth of the projected annual expenses each month, along with an allowable cushion. An initial deposit at closing may occur so enough money is available when the first bills become due.

The servicer periodically analyzes the account and provides an escrow statement. This shows activity such as deposits, disbursements and the account balance. The statement can also identify a shortage or surplus and explain how to handle it.

Money required for escrow can change as insurance premiums and property taxes change. A shortage occurs when the account does not contain enough money to meet its target balance. Depending on the amount and applicable rules, the servicer may spread repayment of a shortage across future monthly payments. A shortage does not change the interest rate on a fixed-rate mortgage.

As a result, your total monthly payment can rise even when your mortgage rate and scheduled principal-and-interest payment stay the same.

Reasons You May Want to Skip Escrow

When a mortgage permits an escrow waiver, you control the funds until the bills are due. You may be able to keep the money in an interest-bearing savings account or money market account. However, some states require you to pay interest on certain mortgage escrow balances.

Skipping escrow also separates property tax and insurance costs from your monthly mortgage payment. You would still face any increases in those expenses but you would manage the higher bills yourself. They wouldn’t become incorporated into a revised escrow payment.

Direct payment can also help you see exactly when you owe tax and insurance bills and how much each costs. The added control comes with responsibility for saving enough money and meeting each deadline. Late property taxes can result in penalties or other collection measures. Failing to maintain insurance required by the mortgage can also lead to additional costs.

How to Know When Escrow Is Required

Escrow requirements vary according to the mortgage program, lender and applicable law. A down payment below 20% may lead some conventional lenders to require escrow, but 20% is not a universal federal cutoff for all conventional mortgages.

FHA loans generally require borrowers to make monthly payments toward applicable property charges, including real estate taxes, hazard insurance and FHA mortgage insurance.

VA rules do not impose a blanket requirement that every VA-backed mortgage have an escrow account. Lenders must, however, address the payment of taxes and required insurance, and individual lenders may use escrow to satisfy those obligations.

Federal rules also generally require escrow accounts for certain higher-priced mortgage loans. Subject to exceptions, these accounts generally must remain in place for at least five years before consumer’s can request cancellation. Additional requirements must also be satisfied before cancellation. ²

If you want to waive escrow when taking out a loan or remove an existing account later, review the terms of your mortgage and ask the lender or servicer which conditions apply. Equity, payment history, loan type, and other requirements can affect whether an escrow waiver is available.

How Escrow Shortages and Surpluses Work

Because future tax and insurance bills are estimated, the amount collected through escrow does not always match the amount ultimately needed. An increase in property taxes or insurance premiums can leave the account below its required balance. Lower-than-expected expenses can produce the opposite result.

Servicers generally conduct an escrow analysis at least once during each escrow computation year. The analysis compares projected deposits and disbursements and determines what the borrower should pay during the next period.

Federal rules govern how shortages and surpluses are handled for covered mortgages. For example, if a borrower is current and an escrow surplus is $50 or more, the servicer generally must refund it within 30 days after the escrow analysis. Smaller surpluses may generally be credited against future escrow payments.

A shortage can increase future monthly payments because the servicer may need to collect both the amount needed for upcoming bills and money to address the existing shortfall. Reviewing the annual escrow statement can help you identify why your payment changed.

Bottom Line

Escrow allows homeowners to fund property taxes, insurance, and certain other mortgage-related expenses gradually instead of budgeting for the full bills separately. The mortgage servicer manages the account and makes the covered payments as they become due. Whether you can choose to pay these expenses yourself depends on your loan and applicable requirements. If you have that choice, you can weigh the convenience of escrow against the control that comes with managing the payments on your own.

Tips for Home Buyers

• The home buying process can be a daunting task, and costs are of the utmost importance. A financial advisor can help. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area. You can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
• Use SmartAsset’s free mortgage comparison tool to compare mortgage rates from top lenders and find the one that best suits your needs.
• If you can’t secure a favorable interest rate on a conventional mortgage, you may want to consider a USDA loan or look into first-time homebuyer programs. These tend to provide reasonable rates for people with less than favorable credit scores.

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