Even if you are looking at buying your first home, I am sure you have heard the phrase “in escrow” being tossed about by other homeowners. Not everyone has an escrow account attached to their ; however, most people do. Continue reading this article to find out what an escrow account is and what it does for you as well as how it affects your mortgage.
What is an Escrow Account?
- Part one: Payment towards your home and the actual loan you owe on it.
- This money is applied directly to the interest and principal owed to your lender.
- Part two: Partial payment towards your homeowner’s insurance.
- This money is placed in your escrow account until your full homeowner’s insurance payment is due. At this time your escrow company will pay the insurance policy for you.
- Part three: Partial payment towards your yearly (or seasonal) property taxes.
- This cash is put into your escrow account each month until your annual or seasonal property taxes come due. When it is time, your escrow company cuts a check to cover the amount of your taxes.
Do I Have to Have an Escrow Account?
Generally, people have escrow accounts because their mortgage lender requires it for the purchase of their house. It is very typical for lenders to require an escrow account for any first-time buyers or for borrowers who do not make substantial down payments. It is up to your lender if it is a mandatory item that you will have to have or not.
An helps lenders by protecting them and the investments they have made in you and your home. It makes it easier for you as well, as it does all the budgeting and setting money aside for your homeowner’s policies and taxes for you.
The Advantages of Having an Escrow Account
This allows most homeowners to budget more efficiently. It is in a way, forcing you to save the money a little at a time. This makes it so that people living on smaller incomes or paycheck to paycheck can still pay for their property taxes and have much-needed insurance policies to protect the house for themselves and the lender.
The Disadvantages of Having an Escrow Account
Just as there are a few reasons that escrow is a great idea, escrow has its shortcomings too. First, among the money taken for your taxes and your insurance, they assess a fee. This means you are paying for a service that with enough discipline, could be done on your own with your regular financial institution. Then, there are the times when things do not work just as they should. Sometimes escrow accounts, can cause issues and missed opportunities. Here are a couple of the most common escrow account issues.
Sometimes escrow accounts can get messed up. Usually, this happens when your lender sells your mortgage to a new servicer. The most typical issue is a delay in funds causing either a gap in insurance coverage or a late payment on your property taxes.
Shortages or overages
Lenders use your homeowner's insurance rate and property taxes from last year to calculate your escrow amounts. If the amount of either of those things fluctuates, it can cause your estimated payment to be incorrect and can result in an overall or a shortage.
Overages are not too big of an issue. This means that you have paid too much. Usually, they apply the amount to your next years estimated total which can make your yearly payment decrease.
Shortages, on the other hand, can cause enormous problems for the average homeowner. This means that they underestimated what you might owe, and your escrow account does not have enough money in it to pay for your taxes or your insurance bill. In cases like this, your escrow account typically has a buffer in it that can cover the shortage.