A mortgage escrow is an arrangement between the homeowner and a third party entity (the lender) in which money is deposited into an account. These deposited funds are then used to pay for expenses related to owning the home. The most common types of expenses paid from a mortgage escrow account include property taxes and home owners insurance, which are generally paid once or twice per year.
Most homeowners have the option of opting out of using a mortgage escrow to pay for things like property taxes and insurance. However, there are some cases when a mortgage will require the use of an escrow account depending on the details of a specific loan. If a borrower were to opt out of using a mortgage escrow account, then they would take on responsibility of paying for these additional expenses on their own.
Advantages of Using Mortgage Escrow
There are plenty of advantages of using a mortgage escrow account. Here are a few reasons why you may want to consider signing up for this service when you buy your next home.
- Large Property Tax Payments – The reality is most homeowners are not disciplined enough to budget for large annual payments like property taxes. Just last year, my annual property taxes were $4,000, which would have been a hefty check to write. Instead of worrying about budgeting for that high of an expense, we chose to transfer money into our escrow account each month (about $330) to cover the property taxes.
- No Late Penalties – One of the best advantages to using a mortgage escrow account is that the third party is responsible for making your payments. This means there is no need to worry or even remember to pay your property taxes as the escrow service handles all of this for you.
- Escrow Accounts are Always Funded – There is no need to worry that your escrow account won’t be funded. Even if there is a shortfall between your escrow balance and one of your expenses, the third party will cover the difference until the next deposit is made into the account. In the event your taxes go up, your monthly escrow payment will be adjusted by the third party to ensure your account is always funded.
Disadvantages of Using Mortgage Escrow
While a mortgage escrow account can make it easier to pay your property taxes, there are some disadvantages as well.
- Escrow Shortfalls – If your property taxes rise, then you may end up with an escrow shortfall. This means that you are not putting in enough funds each month to cover an increase in property tax. While the escrow company will normally cover the difference, the homeowner’s monthly payment will eventually be increased. This increase to the monthly payment is to refund the escrow shortfall and to plan for higher property taxes in the future. Often times the escrow company will overcompensate in this situation, which can tie up more of your personal assets.
- Missed Interest – Would you rather earn interest on your money or let another company earn interest on your money? This is one of the biggest disadvantages of using a mortgage escrow account. A homeowner who is paying $500 in escrow every month may be missing a huge opportunity in lost interest. The $6,000 in annual escrow payments can earn a nice bit of interest over the course of a couple months in a high yield savings account.
Note – My wife and I use to use a mortgage escrow account for the added convenience but declined this service recently when we refinanced our home. We felt the missed investment opportunities were too great to keep letting our bank earn interest off of our money.
Final Thoughts
Using a mortgage escrow account can take a lot of the hassles out of paying for things like property taxes and homeowners insurance. A homeowner who uses escrow doesn’t have to worry about forgetting to pay their property taxes which can be a nice convenience. However, that same homeowner misses out on any interest earning opportunities by depositing money each month into a third party account.
Do you use mortgage escrow for your home? What are your reasons for or against these types of forced savings accounts?
Related posts:
- How to Create Your Own Mortgage Escrow Account
- How to Save on Your Homeowners Insurance Escrow Payment
- How Much Will My Monthly Mortgage Payment Be?
- How to Calculate Your Monthly Mortgage Principal and Interest Payments
- What is a Biweekly Mortgage?
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This something that I think more and more banks will start leveraging more and more so that they will eliminate some of the risk
Solid article John. This is really something that everyone should know if they plan on owning a house. Thanks!
Thanks Derek. We just refinanced and this time opted out of the escrow so we could earn a little interest off our money instead of the bank.
Thanks for your mortgage escrow clear explanation John, it helps.