Generally, home mortgage payments consist of 4 parts:
- principal (a partial payment toward the amount that was initially borrowed)
- interest (the cost of “renting” the remaining loan balance)
- property taxes
- insurance
(These are often called “PITI” for “Principal, Interest, Taxes, and Insurance”.)
When someone borrows money to buy a house, the lender has a good reason to want to make sure that the property is insured and the taxes are paid. (If the house were destroyed in a fire or other calamity and the borrower just walked away, the lender would have no way to get their money out of the property. If the taxes aren’t paid, the local government could seize the house and sell it to pay the taxes.) Because lenders prefer to make sure that insurance and tax bills are paid, and paid on time, they include those costs in the monthly payments and pass the money along to the insurance company and local government. The money is kept in a separate “escrow” account until the next insurance bill or tax payment is due. Federal Housing Administration (FHA) loans always come with an escrow account and include insurance and taxes in the payments.
Many homeowners like escrow accounts just fine. It’s convenient. Not making insurance and tax payments means two fewer things to worry about. Someone lacking in financial discipline might not be able to put enough money aside for the tax and insurance payments, and that could lead to trouble. Forgetting to make the payments can lead to late fees, or worse.
However, someone who is able to manage their money and wants to spend a little extra time doing so might want to consider a no-escrow loan. While this does not reduce your taxes and insurance costs, it does let you keep your money in your own account until you need to make the payments. This might earn you some interest from your credit union or bank where you keep your checking and savings accounts. Additionally, you might more easily meet some minimum balance requirement that eliminates monthly service charges. If you’re making the homeowner’s insurance and property tax payments, those are two more things you can use in your credit-card-churning scheme, if that’s your thing. Remember: taxes and insurance are usually thousands of dollars per year. To make sure you have the money when the bills are due (which may just a few times per year) you need to set aside hundreds of dollars each month. If possible, it’s a good idea to automate things and have money automatically move from your checking to a dedicated savings account — but you still need to keep an eye on things and be sure you’re ready to pay the bill when it comes due.
It’s may be easier to avoid escrow on a new loan and harder or impossible to remove an escrow requirement from an existing loan. In general, in order to remove the escrow account from a mortgage, the mortgage has to be current with no late payments for a year or more, the balance remaining on the loan can’t be too high compared to the appraised value of the house, and the borrower has to have a good credit rating. Even if you can avoid escrow, watch out: banks might charge a higher interest rate on a no-escrow loan. As always, shop around, read the fine print, and negotiate. Finally, in some states, mortgage lenders might be legally required to pay interest on the amount in the escrow account. If that’s the case for you, then it probably makes no sense to have a no-escrow loan.
