When you sign your name for a mortgage on a new home, the most prominent figure that you remember is the monthly payment that you are expected to make. Your payment always includes payments towards your principal and interest. In many cases, it includes prorated monthly payments for the annual amounts that your lender expects to pay for real estate taxes, property insurance and other fees on your behalf.
Many homeowners have escrow accounts where they can keep a lot of money in case they overpay their taxes, don’t pay their interest, or get a tax refund. Escrow accounts provide benefits for both the mortgage company and the payee, but if taxes in your area happen to go down or your payments are overestimated, you will have too much money in your escrow account at the end of the year. Your lender will then pay the appropriate amount to the municipality, and the remaining amount goes to you.
You can send more money to your escrow account every month if you are worried that you won’t have enough to pay your property taxes and homeowners insurance. If you have an overage, though, your mortgage lender will send you a check at the end of the year for any money that is still in the escrow account.
Escrow refers to a third-party service that is part of every home purchase. When a buyer and seller initially arrive at a purchase agreement, they select a neutral third party to act as the escrow agent. The escrow agent collects a deposit from the buyer that is equal to a small percentage of the sale price. This deposit is known as “earnest money”. In exchange, the seller takes the property listing off the market. Until the final exchange is completed, both the seller’s property and the buyer’s deposit are said to be in escrow.
Escrow accounts are a part of the mortgage process homebuyers typically cannot avoid. With mortgages, home buyers typically pay a little extra into an escrow account every month, along with their home loan payments.
While a mortgage holder (most typically a bank) collects the principal and interest payments each month, they also can collect homeowner’s insurance payments and property taxes. They will then pay those bills when they come due. They do this because when you borrow money from a lender to finance your home purchase, the property becomes the collateral for your loan. Your lender needs to know that the property is adequately insured so that it can be repaired or replaced if damaged. Likewise, they want to prevent a tax lien being placed on the property if you neglect to pay taxes.
Most, but not all, lenders require borrowers to take out an escrow account when buying their new home. Under such an arrangement, you will pay extra with each month’s mortgage payment toward mortgage insurance, property tax and homeowner’s insurance bills so you do not have to pay them separately. This also helps the lender ensure that your home is covered by insurance, which protects their loan investment.
When a buyer and seller initially arrive at a purchase agreement, they select a neutral third party to act as the escrow agent. The escrow agent collects a deposit from the buyer that is equal to a small percentage of the sale price. This deposit is known as “earnest money”. In exchange, the seller takes the property listing off the market. Until the final exchange is completed, both the seller’s property and the buyer’s deposit are said to be in escrow.
While a mortgage holder (most typically a bank) collects the principal and interest payments each month, they also can collect homeowner’s insurance payments and property taxes. They will then pay those bills when they come due. They do this because when you borrow money from a lender to finance your home purchase, the property becomes the collateral for your loan. Your lender needs to know that the property is adequately insured so that it can be repaired or replaced if damaged. Likewise, they want to prevent a tax lien being placed on the property if you neglect to pay taxes.
Escrow payments are a common part of homeownership. They pay for important ongoing costs like property taxes and home insurance. But is it a good idea to put more money into your escrow account? There are some good reasons to think about it, but there are also some things that could go wrong. This article will talk about the main pros and cons to help you make a smart choice.
What Is Escrow?
First, a quick primer on what escrow is and how it works.
Escrow refers to funds set aside by your mortgage lender to pay property taxes and insurance on your behalf. Each month a portion of your mortgage payment goes into the escrow account. When annual bills come due, the lender makes the payments from the escrow funds.
With this arrangement, you won’t have to worry about making a budget for big, regular costs. The lender takes care of it for you by getting some money from you every month. Escrow helps ensure these important bills get paid on time.
Now let’s look at the potential upsides and downsides of contributing extra to escrow.
The Pros of Paying Additional Escrow
Here are some reasons why padding your escrow account can be beneficial:
Avoids Shortages
The most compelling reason to pay extra escrow is to prevent shortages. A shortage occurs when there isn’t enough money in the account to cover the upcoming bills.
Common triggers include:
- Property tax increases
- Spikes in insurance premiums
- Underestimating annual costs
Shortages typically require you to repay the deficit in a lump sum or over 12 months. This can mean a painful, unexpected increase in your mortgage payment.
Adding a buffer to your escrow prevents this scenario. It makes sure you have enough money to pay for any increases in insurance or taxes. Paying extra provides a cushion against surprises.
Handles Escrow Increases
Your required escrow amount may still go up every year, even if you don’t have a shortage. This is normal as bills fluctuate.
But coming up with more escrow funds on short notice can be difficult. Putting extra in your account upfront softens the impact of future increases. The excess helps cover a portion of the added escrow requirement.
Earns Interest
One benefit of plump escrow balances is they may earn interest. Your lender generally gets to keep this interest under federal law.
However, some states require paying you a portion of the interest if balances exceed a certain threshold. Check your state’s laws and mortgage documents to understand if you might receive interest on large escrow surpluses.
Peace of Mind
Finally, padding your escrow account can provide peace of mind. You gain assurance that your important property bills will be paid on time, preventing penalties or other headaches.
Knowing you have a healthy reserve built up removes uncertainty. For cautious savers, this added security can be worthwhile.
The Cons of Extra Escrow Funds
Paying additional escrow also has some potential disadvantages:
Opportunity Cost
A dollar paid to escrow is a dollar that can’t be used for other priorities like paying down high-interest debt or investing for retirement. There is “opportunity cost” when tying up money in low-interest escrow.
Analyze whether excess escrow funds would be better applied elsewhere. Make sure the security outweighs what you may be missing out on.
Housing Your Money
You are essentially housing your money with the lender when contributing extra to escrow. This means forfeiting control over those funds.
You need to closely monitor your escrow statements and follow up on any errors. Lenders do make mistakes like faulty accounting or missed payments. Keeping a watchful eye on your escrow activity is wise.
Tax and Insurance Changes
Putting extra in escrow can backfire if your property tax or insurance situation changes significantly. For example, winning an appeal for a lower property value assessment.
Sudden drops in taxes or insurance premiums can lead to overfunding your escrow account. Make sure you understand your tax and policy variables before adding extra padding.
Key Factors in the Decision
As you weigh the pros and cons, keep these key factors in mind:
Your Risk Tolerance – How much escrow risk are you comfortable accepting? The more you wish to hedge against shortages or increases, the more reason to pay additional amounts.
Mortgage Type – ARM mortgages with fluctuating interest rates have higher escrow change risk. Paying extra helps manage uncertainty.
Financial Goals – Will surplus escrow money have a meaningful opportunity cost that undermines other important goals?
Lender Policies – What are your lender’s specific rules regarding overpayments or refunds? Do they pay interest on large surpluses?
Account Analysis – Review your last 1-2 years of escrow activity. Are increases or shortfalls occurring regularly?
Carefully considering these factors will help guide your decision on whether to pad your escrow account. Be sure to reevaluate the decision periodically as circumstances change.
Alternatives to Paying More Escrow
If you decide extra escrow payments don’t make sense right now, some alternatives to consider include:
- Asking your lender to increase your monthly escrow amount
- Opening a separate savings account and self-funding an escrow buffer
- Paying down your mortgage principal to lower required escrow contributions
- Shopping around for lower insurance premiums to reduce escrow needs
- Appealing your property tax assessment if it seems excessive
These options can also help stabilize your escrow situation without having to voluntarily overpay each month.
The Final Word on Extra Escrow
Paying additional escrow can be prudent or imprudent depending on your situation. It certainly helps avoid escrow-related headaches and surprises. But it also ties up your money and reduces flexibility.
Take time to understand the tradeoffs and analyze your specific circumstances and priorities. This will lead to an informed decision on whether padding your escrow account is beneficial. With the right approach, you can develop an escrow strategy that aligns with your financial goals and risk tolerance.
Why Would I Get an Escrow Refund Check?
Typically, when you take out a mortgage, your lender requires you escrow your taxes and insurance. This means that you pay money toward these annual expenses when you make your monthly principal and interest payments. If your escrow account contains excess funds, then you receive an escrow refund check.
Can I Pay My Escrow in Advance?
Your lender will open a mortgage escrow account at closing, when you pay some of the escrow in advance. You will pay no more than one-sixth of the total estimated yearly escrow at closing, which will allow the lender or loan servicer to have a couple of months’ worth of payments in advance.
Should I pay extra on my principal or escrow?
FAQ
Does paying extra into escrow lower my monthly payments?
Paying extra into your escrow account does not lower your monthly payments. The escrow payment is specifically for home insurance and property taxes and cannot be reduced. However, if you want to lower your mortgage payment, you would need to pay extra towards your principal. What Is Escrow?.
Should I put extra money in my escrow account?
By putting extra money in your escrow account, you will not be paying down your principal balance faster. Your lender will only use these funds to bolster your escrow account. Should I pay off my escrow balance? Does paying an extra 100 a month on mortgage?.
Do I need to pay escrow if I have a mortgage?
Both the principal and your escrow account are important. It’s a good idea to pay money into your escrow account each month, but if you want to pay down your mortgage, you will need to pay extra money on your principal. The more you pay on the principal, the faster your loan will be paid off.
Should you pay escrow a month?
However, it’s also important to pay into your escrow account each month to cover taxes and insurance. Both the principal and escrow are crucial, but paying extra on the principal can help you save on interest and build equity in your home. Is It Smart To Make Extra Escrow Payments?.
Should I pay extra on my principal & escrow?
Paying extra on your principal is better if you want to pay off your mortgage faster. However, it’s also important to pay into your escrow account each month to cover taxes and insurance. Both the principal and escrow are crucial, but paying extra on the principal can help you save on interest and build equity in your home.
Can escrow lower mortgage payments?
Paying extra into escrow can lower your monthly mortgage payments by reducing the overall escrow shortage. By putting more money into your escrow account, you can gradually offset the deficit, resulting in a decrease in monthly payments over time.
Is it good to pay additional escrow on a mortgage?
You may want to make a larger escrow payment if you know that next year’s taxes and fees will be higher, and you want to pay the difference in one lump sum ….
What happens if you have extra escrow?
If the escrow account has a surplus of more than $50, the lender must return that amount to the borrower.
Is it better to pay an escrow shortage in full?
Paying an escrow shortage in full is an option that can eliminate the need to spread the shortage across future mortgage payments, but it doesn’t necessarily mean your monthly mortgage payment will decrease.
Should I pay extra on my principal or escrow reddit?
Principal goes toward the balance of the loan. This will help you pay off your mortgage sooner. So unless you know you’ll be short, pay the principal. There’s no point to paying extra towards escrow.