Mortgage Escrow Account Pros and Cons
December 7th, 2022
Everything related to escrow can easily get confusing. Even the concept of escrow may seem nebulous. It often feels like people are talking about different things while using the same terms. And, well, it’s because they are. There are different types of escrow accounts used during different stages of a transaction that are simply called escrow.
This article is meant to clear up the confusion. By the end, you will understand what a mortgage escrow account is, how it is different from the other types, what it is used for, and the escrow account’s pros and cons. So, let’s start.
What Is a Mortgage Escrow Account?
A mortgage escrow account is an account that holds and distributes funds that are used to cover the ongoing costs of homeownership. This account typically exists for the life of your mortgage and the funds come out of your monthly loan payments. The costs that are covered by the account are usually:
Property taxes
Mortgage insurance premiums
Homeowners insurance premiums
We should note that there are different types of escrow accounts, i.e. escrow accounts that serve different purposes. One is the mortgage escrow account which holds and distributes the funds associated with homeownership. When it comes to real estate, escrow is also typically used in two ways:
- The account that is used to facilitate a real estate transaction, sometimes called the home buying account (the account used when buying or selling a house that holds the earnest money deposit, the purchasing contract, the essential documents of the sale, etc.). This account is closed once the sale of the property is finalized.
- Renting escrow accounts are becoming more common. These accounts serve to guarantee that both renters and landlords have fulfilled their obligations and that the basic conditions of a renting agreement are met.
Other than the mortgage, home buying, and renting accounts, escrow accounts can be used to facilitate any type of financial transaction – from trading stocks to online items.
Who Sets Up the Mortgage Account?
Your lender may (and often will, depending on the type of loan) require a mortgage escrow account as part of the conditions for issuing you a mortgage loan. An escrow account will typically be required if you are:
- Taking out a conventional loan from a private institution with less than a 20% down payment
- Taking out a USDA loan
- Taking out an FHA loan
In other situations, you can opt-in to open an escrow account through your mortgage provider. In all cases, the account is set up by your lender and managed by a third party (be it the lender or an independent escrow company).
How Much Money Goes into the Account?
Your lender will calculate the annual cost of your property taxes and mortgage and homeowners insurance. They will divide the amount by 12, add it to your monthly mortgage statement, and deposit the funds into escrow. It is their responsibility to use the account to pay the premiums and taxes when they are due.
Additionally, some states allow for an ‘escrow cushion’. This is extra money that is deposited into the account, more than the calculated cost of the taxes and premiums, which is used to pay for unexpected costs (e.g. if the property taxes increase). If the extra funds become unnecessary (called an overage), they are refunded or credited back to you.
Is a Mortgage Escrow Account Always Necessary?
No, although most real estate experts would advise you to have one. As we’ve mentioned above, you will most likely need to have an escrow account to get a government-backed loan. On the other hand, if you are getting a loan from a private institution and have more than 20% equity in the property you are buying, you should be allowed to opt out of escrow.
The Pros of a Mortgage Account
You Don’t Manage It
Because your lender or servicer manages the account, you do not have to worry about personally making payments from your checking account. Consequently, everything will be paid for on time without your involvement.
You Know What You Are Paying
Bi-annual taxes and insurance payments can severely mess up your finances if you don’t account for them properly. When these expenses are paid by your lender through your monthly mortgage, you know exactly what you are paying and when. Additionally, your lender will cover any increases through your mortgage. If any bill needs to increase, you will be notified in writing.
Can Escrow Lower Your Payments?
Some lenders are willing to negotiate lower interest rates or closing costs if you choose to opt-in for an escrow account. This is on a case-by-case basis, but is definitely something worth checking out.
The Cons of a Mortgage Account
You Don’t Manage It
A mortgage escrow account is used to make automatic tax and insurance payments. This also means that you do not have full control over your finances. For instance, if your account contains the escrow cushion, you may have wished to use the overage for other purposes, instead of having it as backup and getting credited at the end of the year.
Consequently, the automatization can fall into both mortgage escrow account pros and cons.
You Need to Make an Upfront Deposit
Lenders often require you to make an upfront deposit of two or three months’ worth of insurance and taxes to set up an account. This deposit will add to your closing costs. On the other hand, you will need to pay taxes and insurance eventually, so the deposit is only a quickening of the process, not an additional cost.
Do You Need Reliable Escrow Services?
Now you know what a mortgage escrow account is used for and the escrow account’s pros and cons. If you wish to make your life easier and avoid having to think of taxes and insurance premiums, consider Lightspeed Escrow’s services.
We are an escrow company founded by real estate professionals with the aim of making all transactions quick and accurate. It is our job to make your life simpler. If you wish to know more or have any questions about the process, contact us to talk to one of our representatives.
