Should you? Or should you not escrow your taxes and insurance with your mortgage payment?

If you have the option to pay your own taxes, and homeowners insurance on your own without including it in your mortgage payment – is it a good idea to do so? Or should you include it in your mortgage payment?

Before we answer this question we should look at when can you pay your own taxes, and insurance as well as when you have to set up an escrow account with your lender/mortgage company?

When can you pay your own taxes, and insurance separate of your mortgage payment?

• ?If you have at least 20% equity in your home, or if you are putting a down payment of 20% or more.
• If you are in a conventional loan (Fannie Mae or Freddie Mac)

When do you have to set up an escrow account with your lender to pay your taxes, and insurance to be included in your mortgage payment?

• If you are getting, or have an FHA loan you have to set up an escrow account for taxes and insurance with your lender / mortgage company. In an FHA loan you have to include your taxes and insurance even if you are putting 20% down, or if you have 20% equity in your home.
• If you are putting less than 20% down on a conventional loan (Fannie Mae or Freddie Mac) – most lenders will require that you set up an escrow account to include your taxes, and insurance in your mortgage payment.

We should also discuss what the advantages, and disadvantages are of you paying your own taxes, and insurance compared to including them in your mortgage payment.

Setting up an escrow account with your lender

Advantages

• Taxes and insurance will be paid promptly when they have to be paid, and usually any penalty resulting from a late payment at the fault of the lender will be paid by the lender.
• You don’t have to keep track of when school, general, village, and county taxes are due – you make your monthly mortgage payment, and your mortgage company takes care of the rest.
• The money in the escrow account is yours – it is not a fee. When you are able to cancel your escrow account, or if you pay off your loan due to a refinance, or a sale - the balance in your escrow account will be returned back to you.

Disadvantages

• Every year usually on the anniversary date of the mortgage the lender has to analyze your escrow account. If there is a shortage due to an increase of your taxes, or insurance the lender will ask for a lump sum payment to cover the shortage, or they can offer to spread the shortage out over a period of time (12 months, etc.). Either way this will raise your monthly payment and may require a lump sum check to be sent in to the lender. If your taxes, or insurance go down the lender will return the overage that is in the escrow account, and will adjust your mortgage payment down.
• When setting up an escrow account the mortgage company requires a cushion usually of 2 months of taxes and insurance in the account. For example, if your property taxes are $12,000 per year, and your homeowner’s insurance is $2,000 per year your cushion will be $2,333 ($12000 annual property taxes + $2000 annual homeowner’s insurance = $14000 / 12 = $1,166.66 x 2 = $2,333.33). In addition to the cushion of 2 months, the mortgage company also has to escrow for upcoming taxes and insurance that are going to due soon. For the purpose of this example we can assume the bank will hold 6 months of taxes, and insurance ($12000 annual property taxes + $2,000 annual homeowner’s insurance = $14,000 / 12 = $1,166.66 x 6 = $6,999.96). In this example the escrow account will start with $6,999.96 (initial escrow account) + $2,333.33 (cushion for escrow account) = $9,333.29 put into your escrow account for the purpose of paying current, and future taxes and insurance due.

Paying your own taxes and insurance

Advantages

• You get to manage your own money. You can set up your own escrow account with your institution of choice, and put into any account that you like (interest bearing, non-interest bearing, money market, stock, bond, etc.).
• You will have a lower mortgage payment which will consist of just principal, and interest.

Disadvantages

• You have to write the checks for taxes and insurance when they come due. You also have to follow up, and make sure that they cashed your checks and/or processed your payments.
• I have heard horror stories that if you send in your payment, and it is less than the correct amount even by pennies the municipality will not accept your payment, and will return it while tacking on penalties that can be excessive. You have to double check that you are sending the correct amount by the due date.

When deciding which option is the best option for you may want to consult with your CPA, tax preparer, or financial advisor, etc. to determine if this is something that may, or not make sense for your short / long term financial plan, and objective.

Steven Paul Ross