Escrow Accounts: What They Are & How They Work
We’re learning about escrow accounts today!
When you’re getting a mortgage, your monthly mortgage payment is referred to as PITI. That stands for Principal, Interest, Taxes, and Insurance. The part of your mortgage that is locked in is the Principal & Interest (PI) if you are doing a fixed-rate mortgage (there is very little reason not to).
The Taxes and Insurance (TI) fluctuate yearly as insurance costs go up and the home value fluctuates. The TI is also referred to as the escrow. The mortgage company pays these on your behalf. They do this because that way they know it is actually being paid. If you were not paying your taxes, the government could take your home and the mortgage company loses out. So, this is to make absolutely sure it is getting done.
They also keep a reserve of your funds of at least the value of three months of your TI so that if they increase, there are funds there to cover the difference. If they do need to dip into this, it is referred to as a shortage. In this situation, they will either add the missing funds to your TI monthly payment or require you to pay the shortage outright. On the other hand, if there is an overage, they will give you your money back.
If you are putting at least 20% down on the home, you have the option to not have the mortgage company handle the escrow. Meaning that you would pay your taxes and insurance yourself whenever they are due and you would only be paying your PI monthly. Most do not go this route because they worry they will forget to pay for these things, don’t have 20% to put down so they never had the option, or feel it’s easier to let the mortgage company handle it. Also, some lenders charge an increase in the interest rate (ie: 0.25%) if you do this as a way of covering for the possibility that you do not pay your taxes or insurance.
Personally, I prefer to handle the escrow myself that way I only have to pay the PI monthly. Why? Because my monthly costs go down. Being 100% commission and having paychecks fluctuate greatly means the lower the monthly expenses the better. I can typically handle bulk payments with no issue provided there is time to get the funds together. Since taxes and insurance are due once a year, that makes it very easy for me to account for. I also have the perk of not having to fund that three-month reserve for the mortgage company as well. When we refinanced our home, we opted to remove the escrow account and our monthly costs went down about $500 a month. That has helped greatly in the times when I wasn’t getting a paycheck. We will be handling the escrow ourselves on the rental property as well. For us, the lower monthly costs are awesome.
Most will have an escrow account because they are not putting 20% down so they won’t have the option (most do not have 60K+ just hanging around), or they prefer not to have to worry about paying the escrow themselves. There is no right or wrong way to have your escrow. Just what works for you if you have the option to choose.
Do you have an escrow account? Would you prefer to have one or not have one, if it’s an option?
Feature Photo by corina ardeleanu on Unsplash