Escrow: How Much Do You Really Know?
Don’t be taken by surprise when closing rolls around. Escrow payments can make a big difference in your finances.
When you are buying or refinancing a property, you will get a good faith estimate around the time you go into escrow. The estimate will include a line item for escrow account information — also called property tax and insurance impounds.
These are monies that might be added into your monthly mortgage payments to cover property taxes and insurance. The lender may require them, or it may be an option for you. Here’s a look at the details.
Easy come, easy escrow
In the past, a home buyer would borrow money for a home and make monthly payments to the bank. In those days, a borrower would separately pay their insurance and property taxes throughout the year when the bills came due. Unfortunately, sometimes mortgage borrowers with errant budgeting habits and free-spending ways would end up short of money when property taxes were due.
As a result, lenders started offering (or sometimes requiring) borrowers to pay those property taxes and insurance monies into an escrow account on a monthly basis. When those bills were due, the lender would pay them on behalf of the borrower.
The lenders also did this to earn interest on those funds. When hundreds of thousands of escrow accounts are combined, the result is a lot of money, and a lot of interest. Over the years, some lenders began requiring the money upfront, some would give a quarter-point discount on a mortgage interest rate if the borrower escrowed their taxes and insurance, and some would give the borrower a choice.
Borrowers would have to put up a large amount of additional cash at closing to start an escrow account — sometimes up to six months’ worth of property taxes — and they might not be thrilled about the interest they’d be losing by not having those funds invested.
Due to those issues — and especially in cases when there isn’t a discounted interest rate for escrowing funds — most borrowers decline to escrow those monies.
What’s best for buyers?
For most people, escrowing taxes and insurance is a great way to go, especially for first-time buyers and/or buyers who are tight on funds. Since most of us do not sock away money in a separate account for property taxes and insurance, we get clobbered at property tax time. It’s much better to budget and save that money throughout the year, and escrowing these funds with the lender is a great way to force yourself to accomplish this goal.
Ultimately the choice is yours, but it sure is nice to get to property tax time and know you don’t have to come up with a large amount of cash to cover those bills. Since you’ve already saved those monies along the way, you should have a stress-free month while others are scrambling to pay the bills.
