So you’re about to finance a home….one major question you’ll need to answer early on is whether or not you should take the lower payment of just principal and interest and pay your insurance on your own, or escrow it and let the lender take care of it.
While no one likes making their payment than necessary, not everyone can afford the lump sum needed to pay taxes and insurance each year.
Let’s take a closer look at how mortgage escrows work and why most of our clients opt for one.
Mortgage escrow is a practice that is increasingly popular in part because it can act as a safety net for first time homebuyers who might not otherwise be prepared for the shock of property taxes.
A general escrow is a legal agreement where a third party holds the money as a mediator between two parties who are in a buy and sell agreement. This same general concept is at play with a mortgage escrow, but it is specifically geared to help out either first time homeowners or homeowners who are deemed as potentially at risk.
The way a mortgage escrow works is that each payment on a mortgage has a small part that is actually earmarked for property taxes and insurance. That money is held by the mortgage company in an account that is actually in your name.
The money stays there and collects each month, sometimes with a limited amount of interest, until the taxes or insurance payments are due. The bill due is then paid out of that account.
So while your payment is higher each month, you avoid the big payment at one time for insurance and taxes each year.
How Is Your Escrow Amount Calculated?
A mortgage escrow is figured up with a simple formula.
Total annual insurance & taxes/12 (+2)
The amount taken out monthly as part of the housing payment is figured out by taking the total cost of the annual insurance and property taxes, and dividing that number by 12 to get the monthly payment amount.
Each month that amount is put into the escrow and the mortgage company will pay the taxes and insurance when it comes due so the homeowner doesn’t have to worry about it.
At closing, the lender will collect an extra 2 months of cushion which is recommended by HUD. That way there is never a shortfall in your account when the premiums or tax bills are paid annually.
Why Go With a Mortgage Escrow Account?
One of the reasons many homeowners like going in this direction is that the escrow account is simple. You don’t have to worry about saving for taxes or annual insurance because the mortgage company takes care of it.
This isn’t just easier, but it also helps take away the issue of not saving enough for taxes and falling behind. When you have an escrow, this is a non-issue.
Another reason is that since the taxes and insurance are all rolled up into your monthly payment, budgeting becomes much easier. There’s just the one monthly number to worry about instead of three, and that money can’t be raided from the escrow account so you know it will be there when you absolutely need it to be.
The Yearly Review
Every year your mortgage company will review the escrow account and how it is working for you. You’ll find out that if there is too much money in the account, you get the difference back in the form of a check. If not quite enough was put into the account, then they will help you make the necessary adjustment so a shortage doesn’t happen again.
What About Refinancing?
There’s a lot of concern over what happens to the amount already paid into the escrow account when you choose to refinance. Don’t worry – you don’t lose that money! What happens next is a process known as “Netting your escrow.” Instead of sending a bunch of checks back and forth, the amount saved up in the escrow is rolled up with your payment on the old mortgage into the new refinanced one so it’s all taken care of at once.
If you refinance, you will have to set up a new mortgage escrow account if that’s the direction you choose to go with it.
There’s a lot to like about mortgage escrows. They’re not complex and shouldn’t be seen as intimidating. Contacting me today to find out more of if you have any question.