Escrow: The one word that you need to know
Escrow – pronounced ess-crow, not eee-scrow. Now that we have that out of the way let’s get to the question that’s likely on every homebuyers mind; what the heck is Escrow?
Glad you asked. Escrow in the simplest of terms is money that the lender sets aside to pay property taxes and insurance premiums. That’s it. So your monthly payments include the mortgage, the property taxes and the mortgage insurance, in one lump sum.
Escrow is used to protect lenders from tax liens and uninsured losses that the borrower can’t pay, or simply forgets to pay. The two major risks lenders want to eliminate are:
A home’s real estate taxes may go unpaid, go delinquent, and get sold to a third-party
A home's insurance coverage may lapse, and major damage is somehow sustained
So Escrow is there to protect both the lender and the borrower. Can you waive escrow? Maybe. But we’ll get to that later. Let’s stick with the basics for now, like how escrow is calculated and managed. The first thing you need to be aware of is that your monthly payments can, and usually do, fluctuate, most likely from year to year. The reasons being either rate changes for mortgage insurance premiums and/or changes in property taxes.
There is a standard formula for calculating escrow. The math is simple. Divide the total of your insurance premium and your annualized property taxes by 12. If you owe a total of $2400 in property taxes and $1200 in insurance premiums that would equal $3600. Divide by 12 and you would have to pay $300 per month into your escrow account. That’s $300 on top of your monthly mortgage payment.
Now I mentioned earlier about the ability to waive escrow. Many different lenders require escrow for certain types of mortgage loans.
FHA loans - The Federal Housing Administration (FHA), requires that lenders making FHA-insured loans establish escrow accounts for those loans.
VA Loans - The Veterans Administration (VA) does not require lenders to maintain escrow accounts on VA-guaranteed home mortgages. However, the VA does require that lenders ensure that the property is covered by sufficient hazard insurance at all times and that property taxes are paid.
Conventional Loans - With conventional mortgage loans, the lender decides whether or not to require an escrow account. Most conventional loan contracts contain a clause requiring an escrow account unless the lender waives this obligation in writing.
The real question here is why you would want to eliminate escrow. Most borrowers look at escrow as a safety net that ensures they are compliant and up to date on payments. For many, the monthly escrow deposit is a good alternative to paying all at once. And many lenders will charge a ‘waive’ fee that can raise your mortgage rate as much as 0.25 percentage points.
See, escrow isn’t as scary as it sounds. It is pretty much standard procedure in mortgage lending. If you are still unsure or have questions I encourage you to speak with mortgage specialist.