Tax & Insurance Escrows

February 4th, 2011

Escrow generally refers to money held by a third-party on behalf of transacting parties. In the case of a mortgage, a lender will hold money in escrow on behalf of the mortgage borrower to pay the property tax and homeowners insurance bills as they are due. Escrows are mandatory on all loans with less than a 20% down payment. These loans include 5% down and 10% down Conventional loans, as well as FHA loans which require a 3.5% down payment and a VA loan which requires 0% down payment.

Investment property loans mandate an escrow account. However, when you have a 20% down payment or greater, and the home will be your primary residence, you can get a non-escrow loan if you desire. There may be a fee to do a loan with no escrows. This is a loan where you do not have to escrow, and you can pay the property taxes and the homeowners insurance on your own.

Why lenders like loans to have escrows is that it reduces risk of default or foreclosure. If mortgage lenders let everyone pay their own taxes and insurance, then when a mortgage borrower did not pay their taxes, for example, the collateral of the lender (the house) may be at risk since the county/city can start foreclosure proceedings to collect on the back taxes. Also, many states do not require lenders to pay interest on the escrows, so the lenders can make a bit of money on holding the escrows.

Some states mandate by law that the lenders have to pay interest on escrow accounts, and some make it law that the lenders have to give a mortgage borrower the option to have a “no escrow” loan if they have 20% down. But that does not mean that the banks can’t charge for that option, and most do. There are some states, California is one of them, where most banks will do a no escrow loan and will not charge any extra for it. In many other states there will be a charge, even if the mortgage borrower has 20% down, for the no escrow loan option. The charge is usually an extra 0.25 point in points (which is $250 per hundred thousands dollars of loan) or 1/8% extra on the interest rate.

I can tell you after well over 3,000 loans in my career that it is very rare for lenders to make mistakes on a tax escrow account, and mistakes that are made are quickly rectified. To me, I don’t know that paying taxes and insurance on my own, or letting the lender pay them, is a big deal either way.

And there are people that talk about the lost interest income, when letting the lender hold the money over the course of the year for escrow accounts. But if you have $4,000 in escrow, on average, and that is money you’d usually take out of a checking account that likely earns little to no interest, I don’t see that there is that much lost interest income, if any. $4,000 x .25% on interest bearing checking accounts is $10 a year.

If you insist on paying taxes and insurance on your own, and you have a 20% down payment or more, then make sure to talk to your lender to see if there is a charge to do a no escrow loan, and if so, find out how much it is.

And its important to note that when you are buying a new home and and the lender is establishing an escrow account for homeowners insurance that they will have you pay your first year’s insurance bill in advance at settlement and then put as much as 4 months of the insurance into the escrow account as well. That is 16 months total, which is 12 months for the first year, 2 months for cushion, and 2 more for the gap from the fact that the new loan does not start until the first of the month of the second month after settlement. For example you may go to settlement on June 5th 2015 and then your first payment would be due August 1st 2015. So by the time your policy renewal comes up the following June 5th 2016, you will have only paid ten monthly mortgage payments from August 2015 through June 2016 . So after 10 monthly mortgage payments towards the next annual insurance bill the lender would be two months short without collecting two months for the gap.

People also often want to know if they will not be paying the insurance bill into the monthly mortgage payment for the first 16 months since they paid 16 months in advance. And the answer is that you will be paying 1/12th of the annual insurance bill right from the start of the first mortgage payment. Remember that the point of the escrow account is to make sure that there is always money in the escrow account for each upcoming insurance or property tax bill as illustrated above.

Brian Martucci is a loan officer for Capital Bank Home Loans, a division of Capital Bank, N.A. He has been in the mortgage industry since 1986 and has served in a number of roles, including loan processor, loan officer, mortgage broker, branch manager, and vice president. Brian Martucci – NMLS# 185421. His opinions do not necessarily reflect the opinions and beliefs of Capital Bank Home Loans or Capital Bank. Capital Bank, N.A.- NMLS# 401599. Click here for the Capital Bank, N.A. “Privacy Policy”.

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