Should You Leave Your Tax and Insurance Payments in Escrow?
Mortgage And Property Tax
Your monthly mortgage payments include the principal, interest, property tax, mortgage insurance, and homeowners insurance. Usually, the lender determines how much property tax you pay each month by dividing the yearly estimated amount by 12. This is added to your monthly mortgage payment.
Since the yearly property tax used in the calculation is an estimate, there is a chance you may have to add more money at the end of the year if the property tax was underestimated. If it was overestimated, you would get a refund.
Property tax is paid to the local government and it’s usually collected yearly or twice a year. When you pay your property tax, the lender pays your monthly property tax payment into an escrow account. Then, the lender uses the money in that account to pay the taxes at the end of the year (or whenever due).
Lenders generally prefer that you pay your tax this way so they can protect themselves. The property can get foreclosed if the lender leaves the property tax payment to the homeowner and the homeowner does not make the payment. When this happens, the lender has to pay the property tax lien before reselling the property.
Best Way To Pay Your Property Taxes
The amount of property tax you pay depends on the assessed value of your home. Usually, this is determined by an assessor. The assessed value of your property is multiplied by the local tax rate to determine your tax bill. There are two main ways to pay your property tax bill; the first is paying it as part of your monthly mortgage payment, the preferred method for most lenders. The second option is to pay it directly to your local tax office.
The first option is regarded by buyers and lenders as the better way to pay your property tax if you have a mortgage. Your estimated annual tax bill is divided by 12 and added to your monthly mortgage payments. This helps protect the lenders in case of foreclosure and ensures you only pay in small installments. This is usually more advisable than paying the total sum at the end of the year or after six (6) months.
Also, some lenders offer lower interest rates when you choose to pay your property tax this way. The other option is to pay your taxes yourself. This can happen after you pay off your mortgage or if you reach an agreement with your lender that allows you to do this. You can usually only make such an arrangement if your loan-to-value ratio is low.
Taking Care of Your Escrow Balance
An escrow analysis is conducted yearly. It involves the lender reviewing how much payment you made to cover your property tax and insurance. The lender can decide to increase or decrease your escrow payment. Usually, escrow accounts are required by mortgage companies to hold two (2) months’ worth of payment at any given time. If any of your insurance and tax costs increase, there will be an escrow shortage. Your escrow balance may still be positive, but the money left in it won’t be enough to cover future payments. An escrow shortage means that you will have a negative balance in the future if your monthly escrow payment is not increased.
Escrow deficiency occurs when there is a negative balance in your escrow account. This happens after an escrow analysis is done at the end of the year and the lender realized that they didn't take enough money from you to cover your taxes and insurance.
For either of these scenarios, you have two (2) options. You can either pay off the shortage/negative balance if you can afford it or you roll the negative balance or shortage over into the new year and add it to your monthly payments for the new year.
Plenty of expenses come with buying a home. Three of the bigger ones? Property taxes, homeowners insurance and, for many buyers, private mortgage insurance. Paying these bills can require homeowners to come up with $8,000, $9,000 or more than $12,000 a year, depending on where they live.
So the question is: Do you trust yourself to save up the money to make these payments on your own? Or would you rather have your mortgage lender collect the money to pay for your insurance and tax bills each month and then make the payments on your behalf?
If you choose the latter option, you'll enter into what is known as an escrow agreement with your mortgage lender. Under an escrow arrangement, you'll send in extra dollars with each of your monthly mortgage payments. Your lender will deposit this money into an escrow account. When your property taxes or insurance bills are due, your lender will use this money to pay them on your behalf.
This is convenient. But not every home buyer wants an escrow arrangement. Some want to pay their property taxes and insurance bills on their own, arguing that they'd rather have a lower monthly mortgage payment or that they can make better use of their dollars than watching them sit in a non-interest-bearing account managed by their mortgage lenders.
Which choice is right for you? It all depends on how financially savvy and disciplined you are.
"To make these payments on your own, you do have to be disciplined," said Staci Titsworth, regional sales manager for PNC Mortgage in Pittsburgh. "You have to make sure that you actually do set aside the money for your taxes and insurance. These are not small bills. You don't want to be surprised when the bills come. You don't want to be scrambling to come up with $6,000 at the last minute."
The PITI formula
Consumers don't always realize all the pieces that go into their monthly mortgage payment. Titsworth and other mortgage pros use the acronym PITI to explain it: If you have an escrow agreement, your money each month goes to pay off your mortgage loan's principal balance, interest, taxes and insurance -- or, PITI.
Say your property taxes for the year are estimated at $6,000. You'll pay $500 each month to cover these taxes, money that your lender will deposit into an escrow account. If your yearly homeowners insurance costs $1,200, you'll pay $100 each month, money that your lender again will deposit into your escrow account. This means that you are paying $600 extra each month to cover your property taxes and homeowners insurance.
When your insurance bills and property taxes are due, your lender dips into your escrow account to pay them for you. You don't do anything, except contribute the necessary dollars with each mortgage payment.
The benefit of this? Mortgage lenders say that convenience tops the list.
"There is peace of mind with escrow," said Doug Leever, mortgage sales manager with Tropical Financial Credit Union in Miramar, Fla. "You don't have to worry about putting that money aside."
He has a point. Tax bills and insurance payments can sneak up on homeowners if they're not disciplined enough to stow away the dollars needed to cover these bills during the year.
"There aren't any shocks," Leever said. "There's no, 'Whoops, we forgot to save and put that money aside.' You don't have people having to scramble, having to put the payment on their credit card it take it out of their savings."
Some lenders might even charge a fee to borrowers who want to pay their property taxes and insurance bills on their own. Others require that borrowers enter into escrow agreements if their loan-to-value ratios are 80 percent or higher. So, if you owe take out a mortgage loan for, say, $180,000 on a home valued at $190,000, the odds are high that your lender will require that you enter an escrow agreement with them.
The other way
Some borrowers, though, forgo escrow and handle their property taxes and insurance bills on their own. What is the benefit of that?
It mostly comes down to interest. Homeowners don't earn interest on their money when it's in an escrow account. Some owners would rather set aside their property tax and insurance money in interest-bearing accounts so that these dollars can earn money before they have to go to taxing bodies and insurance companies.
"Many homeowners are very disciplined with their finances," Titsworth said. "They allocate so much money to these payments every month. Some customers like the convenience of having a lower monthly mortgage payment and having that control over their money. It really does depend on the customer."
Which choice is right for you? You'll have to look at your own financial history. Do you already set aside enough money to cover your monthly payments? Or do you have to scramble each month to find the money to pay your credit card bills, mortgage payments or utility bills?
If you're not financially disciplined, an escrow arrangement probably makes more sense. If you are? Then you might want to try covering your property taxes and insurance bills on your own.
Frequently Asked Questions
Yes, they are usually included. The money is held in an escrow account and your tax payments are made for you by the lender.
No, you don’t. Your property tax is made to your local tax office at the end of the year or every 6 months. The money you pay is held in an account by the lender and is paid at the appropriate time.
An escrow account is an account held by your mortgage lender that contains the funds to pay your property tax and homeowners insurance. It is not the same thing as property tax.
Paying property tax through an escrow account is preferable if you have a mortgage. Lenders usually offer buyers lower interest rates for paying this way.
In the case of an escrow shortage or an escrow deficiency, you can choose to pay off your balance if you can afford it. If you can't, you can rollover the payment and add it to your monthly payments for the new year.