I recently got a refund from my mortgage escrow servicer, as my property taxes decreased. This reminded me about how I always used to read that you should manage your own escrow account. I don’t think I have a choice about the matter right now, but I tried to research all the pros and cons below. Did I miss something? Share your own reasons in the comments, and don’t forget to vote in the poll below!
Escrow Definition and Background
When you borrow money to buy a house, the lender holds your house as collateral in case you stop paying them back. However, in certain cases the lender can lose control of their collateral. If nobody pays the city and/or county property taxes, the local government can seize the house and become the first lienholders on the property. Similarly, if the house burns down or becomes flooded without insurance, then they’ll be in trouble too. This is why most lenders require the funds for these types of charges to be automatically collected each month and placed in escrow, until the respective bills are actually due.
Now, most homeowners of course want to pay these things, but as with other big bills, many people may not plan ahead and later find themselves unable to pay. Some lenders may allow you to manage these things for yourself once you reach a certain amount of home equity (loan-to-value ratio) or if you pay them a fee or a higher interest rate.
The Real Estate Settlement Procedures Act (RESPA) provides several requirements regarding escrow. The maximum “cushion” a lender can accrue is for 1/6th of the total amount paid out, or approximately two months of escrow payments. While some states require interest to be paid on escrow account, RESPA does not.
Reasons To Manage Your Own Escrow
- Earn interest. This is the reason I hear most often. You pay out a lot of money ahead of time, when you could be earning interest on those funds instead. Even if you don’t have it as as lump sum, you could tuck away 1/12th of your insurance and tax bills every month on your own.
- Avoid payment errors. Even though the whole point of escrow is to pay your taxes and insurance on time, escrow servicing companies still make mistakes occasionally, resulting in lost payments and big headaches.
- Increase tax deductions. If you think that you will be able to itemize deductions in one year and not the next on your tax return, you may try to “bunch” deductions so that they end up in the preferred year and save you some money. For example, you could pay your 2010 taxes in January 2010, and your 2011 taxes in December 2010, so they both occurred in 2010.
Reason Not To Manage Your Escrow
- You have no choice. Many lenders, like the Federal Housing Administration (FHA), require escrow for the life of the loan. Others, like PenFed only allows you to manage your own escrow once you reach a 75% loan-to-value ratio. If you’re shopping for a new loan, this is a possible negotiable item.
- It costs too much. Some lenders will let you waive escrow, but only for a flat fee (possibly hundreds of dollars) or a quarter to half point (0.25%-0.5% of your loan value). That could be end up being a bad financial trade-off, especially if you don’t keep your mortgage for very long.
- Simplicity and convenience. Hey, it’s one less thing to worry about, and your monthly expenses stay more constant. Technically, if you are short on your escrow, the servicing company will even cover the difference for you and just make it up over the next year. You can view it as a service provided in exchange for any lost interest. If your annual taxes and insurance premiums total $1,500, that is $30 per year at 2% APY, which even assumes that you lose an entire year of interest. Of course, interest rates may rise later.