Do You Escrow?

The following is a guest post from Budgeting in the Fun Stuff. 

As many of you know, when you buy a home, you get a choice to escrow your property taxes and insurance payments or not.  What a surprising amount of people don’t know is what does that mean?

If you choose to escrow, the mortgage company will establish an escrow account for you with a neutral third party to pay property taxes and insurance for your home.  Your mortgage payments will be adjusted to include this estimated amount and readjusted as scheduled if the property taxes or insurance charges fluctuate.  They may also be adjusted for incorrect estimations.  Also, if you escrow, keep an eye out for an escrow fee in your closing costs.  According to this site, that fee could range from $500-$1500.

If you don't choose to escrow, you will be in charge of paying your own property taxes and insurance bills.  Your mortgage payments will stay the same since they will not need to be adjusted for these amounts.  Keep in mind, some banks will charge a fee to waive escrow as well.  According to our closing paperwork we paid $250.  Now that I know what that means, I would have argued to have that removed.  Ah, to live and learn.

My husband and I chose not to escrow for three main reasons:

1.  We wanted consistent mortgage payments.
2.  We wanted to make interest off of our money.  At the time, ING was paying more than 4%.
3.  I didn't want to rely on an escrow company to pay my bills.  I’ll admit it, I'm a control freak.

Looking back, I'm very happy with our decision.  Our mortgage payments have been exactly the same as planned, we make 2.15% at Smarty Pig on our property tax and insurance money, and we've never been late on any of those bills.  We also receive our annual property assessment by April, so I'm never surprised by our November and December property taxes and can easily budget in more than enough.

Do you escrow?  If so, how has it worked out for you?  Did I miss anything important?

Comments

[Dave Boynton]

On my last mortgage refinance I opted for no escrow account. My settlement statement doesn't show a charge for that decision but my mortgage provider required quarterly faxes/mailings showing proof of payment of the property taxes. It became a PITA so I switched to an escrow account. There was no fee to do that.

[Jamie]

If you currently use an escrow account, can you opt out of it?

[TJ]

I HATE escrowing. Something always gets screwed up or paid twice. Also, it took us over 3 weeks to get our escrow money back after closing.

We have opted out of it for our last 4 homes with no problems and no waive fee. However, I think all of our lenders did require 20% to escrow.

I believe there is a additional work and fees if you try to waive escrow after your loan is established, as you are changing the terms of the loan. If you aren't going to be there forever, I would just wait until your next home or refinance.

[Strick]

Back when I still had a mortgage I liked it because taxes/insurance was one less non-monthly thing to budget, and I frankly didn't realize I had a choice (I assumed the bank didn't want to end up with a house and a tax lien so required it).

[Anthony]

I have the same question as Jamie.

I was an ignorant 20-something (still am!) when I closed on my house. I didn't know that there is an option NOT to escrow. I guess this would depend on your mortgage company as well, though.

I would like to do what the article mentions, save the insurance and taxes and earn interest off of them.

[Holly]

Jamie and Anthony:

You would likely be able to be released from escrow by proving that you have 20% equity in your home (if you did not give a 20% downpayment when you originally closed on the mortgage); we had placed 10% down on our first home and as its market value increased over a few years we hired an appraiser to prove we had at least 20% equity and forwarded the report to our lender. At that point we were released from escrow and no longer had to pay PMI (which at the time was $90/month!).

Check w/your lender as this all depends on their mortgage requirements.

[Lisa]

Great post! I didn't realize we had a choice either. I remember asking at the closing however they said it was not possible and that it had to go through an escrow account. I will be checking with our mortgage company. It would really be nice to have this option. :)

[Kevin S]

I invest in rental properties, and I have nothing bad to say about using an escrow account- it smooths out cash flows, and I have never had a problem with double payments, or missed payments (which is their liability, not yours), and when I have overpaid, they wrote me a check with interest included. What's not to like? Are you really investing that money and making significant returns on it? I guess it may make a difference that I am in a very high tax area, taxes are a big deal.

I don't know if they charged a fee to do so at closing... that would piss me off, but I was young and much more passive then and just said ok when they handed me the docs with a page full of fees.

[Jenna]

When my husband and I bought our home, we with all honesty, probably shouldn't have. We had no downpayment or even closing costs - all of that had to be rolled into the loan. Our mortgage company required that we pay into escrow, because our loan was a high risk one, which was something I tried to fight. But 3 years later, I'm really glad we did. While I agree with other posters that I'd rather have my taxes and insurance money earn me interest, it simplifies my monthly budget - 1 payment every month - and it's 2 less bills I have to remember to pay. We've never had any problems with the escrow group paying our bills ontime and every year I get a detailed statement explaining how much my payment will change to account for higher taxes and rates. For us, the ease of it all makes it totally worth it and I probably will continue to use the escrow option on my future homes.

[MC]

When I got my mortgage, I didn't think I had an option to pay my taxes and insurance myself.

I thought the lender required it, so they could make sure you didn't drop your insurance or accumulate county tax liens on "their" property?

What annoys me most about my escrow at present is they want a "cushion" in there over an above what they and everyone knows what the taxes and insurance are going to be for the year. The cushion is $250. So basically they get to play with that amount of my money for free for 30 years--sucks.

My escrow also has now predicted that taxes might rise in the next couple of years, so they are collecting more $ NOW just in case.

I suspect it's just a way to keep more of my mortgage payments from going to pay down the principle at the time I actually pay them.

Escrow changes shouldn't be allowed without permission by the mortgagee.

[Michael Goode]

On my last property I was told I had to escrow. Unfortunately National City Mortgage messed up and caused problems my mis-reserving and other problems; they did this twice! If given the choice I would never escrow. The only ones who should escrow are those who have trouble budgeting.

[MSC]

I don't have an escrow account, because the mortgage bank always over-estimated the amounts, refunded me a big check, and never paid any interest. There was no restriction on not having an escrow unless you were at 80% equity. That idea was for avoiding PMI, which you can also do with an 80/20 loan.

This also brings up an interesting discussion, FMF, about the illusion of earning interest off of "float" when delaying recurring payments, like utility bills. You only earn real interest off of the first month of a loan or monthly bill. The longer you delay payment, the shorter the time the next set of funds has to earn anything before it has to pay the next bill. You essentially take the money out of action every time you make the following payment. Float only works on the first cycle. Having no escrow from the first year cycle of a mortgage just gives you the whole year to earn the interest in the first cycle.

[MSC]

@Michael: My experience with over-estimating escrow was also with National City. When I get a fixed-rate mortgage, I expect the payments to be essentially "fixed".

[jclimber99]

One good reason to NOT escrow is that if your property taxes are due in January (like mine) it is nice to decide to pay in December or January. That way you can double up deductions in the years you itemize and have no property tax deduction in the years you dont. This works well if most of your mortgage is paid off and you don't have enough deductions yearly to overcome the $11400 (married) standard deduction.

If you escrow you most likely will not have this choice. Of course if taxes are due in the middle of the year then the point is moot.

[Claire]

I currently don't have an escrow account and prefer it that way...but I'm in the middle of a re-fi, and the new mortgage will require me to escrow because the value of the house has dropped so much. I have checked and re-checked and when the valuse of the house is back at 80% of the loan, then I can just drop the escrow account no questions asked.

I prefer not to pay escrow because the bills are due one month, but not late until about 2.5 months later. I'd rather keep my money for 2.5 months, but I think the escrow company will pay on the due date.

[Holly]

It's always good to know exactly what you are paying for taxes and prop. insurance from month to month. It seems too passive for me...I like knowing whether I am paying too much for taxes relative to the neighbor (is it time to ask for a reassessment?) and whether or not I should be shopping around for a better insurance rate; It's less transparent when costs are buried in a mortgage payment.

[Budgeting in the Fun Stuff]

According to multiple sites I found online, you can leave mortgage escrow like Holly said - usually after you have 20% equity and sometimes there is a fee ($100-$250 seems to be the norm). If there is a fee, it will be listed in your closing contract.

Kevin S, you seem to be lucky that your escrow company pays interest. Some don't. We currently save our interest and insurance cash in Smarty Pig at 2.01%, and it's going up to 2.15% this month. We have kept it in ING in the past and will do so again when their interest rates get more competitive (currently at 1.1%...was around 4-4.5% when we first decided not to escrow). I just rather have complete control than depend on an escrow company.

[Bad_Brad]

I escrow because:

1) The amount of interest I would earn off the money is minimal
2) Twice per year payments are easy to forget, and if I even missed one payment, the penalty easily exceeds the amount of interest I would have earned on the money
3) Missing property tax payments has other consequences I don't want to deal with (i.e. the state/county putting a lien on my property, hit to my credit score, etc)
4) It's just simpler this way

I know it's not technically the right thing to do from a Finance standpoint, but to me, simplicity and safety have value, too.

[Budgeting in the Fun Stuff]

Bad-Brad, it may be simpler if you have a good escrow company. From a few stories above and ones I've heard from my in-laws, not all escrow companies make it a painless process. I just know that my bills are due in December (taxes) and April (insurance) and I'm good to go. I'm glad escrow works well for you though.

[Old Limey]

I have purchased four properties in my lifetime and have never been asked if I wanted the Title & Escrow company to handle my property tax or insurance payments - this must be something new that has come along since my last transaction a long time ago. I have been asked to show proof of homeowner's insurance but that's all. As a matter of policy I never pay anyone money to do something that I can do myself so I would have declined if it had ever come up.

[Justin]

I agree with Bad_Brad's points. The interest is very minimal and not escrowing means that you have to set aside money to pay the bills later in the year. It's too tempting to spend the money and put yourself in a bad situation later in the year. I don't understand when people gripe about having to pay taxes at the end of the year and painting a picture as if the situation has been a burden on their wallet. They probably didn't escrow and spent the extra cash on stuff. I look at the lost interest as payments for less stress. I've got enough to worry about...

[MSC]

One more time...you don't earn interest by floating recurring payments! It's an illusion.

When you get a mortgage, the bank usually requires you to pay a prorated amount depending on the due date of your local property taxes, and to get insurance the day you walk in the door. You don't get to wait a year earning interest in a savings account to start paying taxes and insurance out of escrow. If you had not bought the house, taken the loan, hooked up the utility, or otherwise taken on a recurring payment that you didn't have before, the money you spent would have been in your account earning interest. Loans and mortgages pay interest to the lender anyway, so the leverage of your money to buy a big ticket item only affects your cash flow, not the interest you earn on the funds leveraged.

Floating is a process where both banks are paying interest on the same funds due to delays in interbank transfers. It's not the same as delaying payment 30 days from getting your bill, or paying it right away. It's not the same as paying your taxes and insurance in escrow every month, or paying it once a year. If you pay the portion of one year's taxes and insurance over 12 months, or you pay it one time every year for the next 30 years, makes no difference in the interest you earn on savings. Float doesn't work that way for individuals.

Think of it this way. If you make the first payment on a loan when due on May 1, the next payment is due June 1, or 30-days later. Your payment funds have 30 days to accumulate interest or APR. If you pay the next bill July 15, allowing for a grace period of 15 days, the amount of that payment gets 45 days to earn interest. However, the next payment will either be 15, 30, or 45 days away, and whatever float you may have earned will be averaged out to 30-day periods until the loan is paid off, or the monthly utility bill is turned off. You still have to pay every 30 days on average, or every year out of escrow. The later you make one payment, the sooner you'll have to make the next one. Whatever funds you leveraged for interest over 45 days will be negated by the funds you have to withdraw much earlier to pay the next bill.

The same is true when making January's mortgage payment in December. You'll get a extra deduction come tax time, but next year, you'll either have made 11 payments, or 12. It still averages out to 12 recurring payments. That's why there's no tax benefit to making 13 mortgage payments the first year, and 11 the next, unless you have a special circumstance regarding your withholding or exemptions to cover in a particular tax year.

It's a classic example of the "shell game".

You should try to pay outside of escrow only because of the unethical practices of lenders who overestimate the cushion they need from you, and to keep fixed payments "fixed".

The idea of float also doesn't work when under-withholding federal taxes every paycheck, versus paying them all at once April 15. The interest you earn off the extra cash flow is prorated over 12 months as APR, instead of getting a one-time boost when you get that fat refund check that you have to spend down when you have lower cash flow during the year. You only give the government "free money" to earn when they exercise real float between the central banks.

[Budgeting in the Fun Stuff]

Justin, I understand the less stress part if the person in question is tempted by money. But most personal finance enthusiasts are usually the opposite.

We have $400 taken from ING Checking and put into Smarty Pig every month, so it's not stressful. I never once have looked at the tax and insurance account and been tempted to spend it. Obviously, it ends up depending on the person.

[VT]

Choose? I've bought/sold three houses and none of the lenders would allow me to opt out of escrow, and I asked. (and we did have the 20% down in two of the cases).

[Budgeting in the Fun Stuff]

VT, based on what I can find, that doesn't make sense. There's usually a fee to waiving escrow ($250 in my case), but it should be possible. I'll see if I can find any specific lenders that don't allow a buyer to opt out of escrow.

[Rick]

MSC, it's not clear who you're arguing with. The only person that mentioned float in this thread is you. Nothing anyone else said appears to be describing or implying a "float" situation with escrow payments. As you say, float requires having the same money earning interest at two places at the same time. No one suggested that.

However, you do seem to be saying that there's no financial benefit in taking advantage of a recurring bill's grace period or in paying your own taxes and insurance versus paying into a (non-interest bearing) escrow account. I'm having trouble following your logic. In each scenario you discuss, you're arguing against this basic idea: "I have x dollars. With these x dollars, I have two choices: 1) I can give it away immediately; or 2) I can use it to earn interest for y days before I give it away."

In your example, I have a loan payment due the 1st of the month, with a 15-day grace period. On the 1st of every month I have the funds available in my interest-bearing account to make the loan payment. Instead, I leave the money in my account and make the loan payment on the 15th. That situation repeats itself *every* month and the actual financial benefit - 15 days of interest - compounds *every* month.

Your argument that there's no effective difference between a "fat refund" and a balance due on April 15 is illogical for the same reason. For a period of time, you're choosing to have a chunk of your money just sit on its ass instead of working for you. The fact that that money comes back to you later as a "one time boost" and starts earning interest can't make up for the lost time.

Your comment against shifting January's mortgage payment into December to get 13 months of interest deduction in one year will normally be true, although I don't see how withholding has anything to do with it. I think the rare cases where it would work have more to do with your itemized deductions perennially being close to the standard deduction amount, as in jclimber's situation. Being close to the edge between two tax brackets could make this an even more valuable tactic. But again, probably not for the vast majority of homeowners.

[Timmy in Houston]

Mortgage companies will typically charge a quarter of a point to waive escrows. You can often get them to waive this fee, depending upon how attractive other components of the loan are for them (origination fee, paying points to bring down the rate, other fees, etc.) I have successfully used this point as a negotiation tool when shopping lenders.

[kitty]

@MSC, Justin, everyone who worry about missing payments: you are assuming that bank is always on time. Banks make mistakes too, but you are the one responsible.

On my first property I did have an escrow, but I bought it with less than 20% down so it wasn't a choice; plus even if it were, I wouldn't have known about it. But after I moved, the mortgage holder on my next property offered me this option for free, in fact it was a default. This was a special deal - I got a package from my employer for relocation which included good terms on a mortgage from a specific company (including full closing costs paid by my employer). The catch was that 20% was a requirement to get mortgage from this company. Anyway, they just gave me a paper to sign if I want to pay my own taxes, and I thought - why not? Interestingly, a co-worker of mine didn't get an option for no escrow, when she called and ask they told that her mortgage was considered a riskier one because her husband was self-employed. I liked not having an escrow, so from then on I've always chosen this option for pretty much the same reasons that FMF mentions: I like to be in control and I don't want to pay months in advance.

[Budgeting in the Fun Stuff]

kitty, I actually wrote the post, but you bring up a good point. FMF, do you escrow? :-)

[kitty]

@Budgeting in the Fun Stuff - sorry, didn't pay attention to who wrote it... I meant you, of course.

[FMF]

Budgeting in the Fun Stuff --

I don't have a mortgage. ;-)

[Budgeting in the Fun Stuff]

FMF,

LOL, yeah, I knew that *smacks her forehead*. Sorry, I meant, did you escrow? :-)

[FMF]

Budgeting in the Fun Stuff --

I did. Back then, I didn't know it was an option not to. :-)

[Budgeting in the Fun Stuff]

FMF,

OMG, you weren't born financially all-knowing? LOL. ;-)

I'm happy that this post might have actually given a few people an option they didn't know about. I was worried that FMF readers would have been like "yeah, duh". :-)

[Michael]

I don't have a mortgage and didn't escrow when I did, this year I'm using Smartypig to earn some interest til Nov, when both insurance and taxes are due.

[Jay]

I have the bank escrowing mine right now (that may change in the near future). However my question is can the bank withhold those tax payments from city's tax collector when the city is not performing the services they are suppose to (eg. snow removal). It seems that the law is against the property owner in this and that you have no right to withhold money for taxes when services are not performed.