Is Having an Escrow Account Good? The Pros and Cons of Escrow Accounts

Escrow accounts are a common part of the home buying and mortgage process. But is having one actually a good idea for you? There are several pros and cons to consider when deciding whether to set up an escrow account. This article will break down what an escrow account is, how it works, and the main benefits and drawbacks of using one for your mortgage payments.

What is an Escrow Account?

An escrow account, also known as an impound account, is a special account used by lenders to pay a borrower’s property taxes, homeowner’s insurance premiums, mortgage insurance and other recurring housing expenses

Here’s how an escrow account works:

• When you close on your mortgage loan, you will deposit a sum of money, usually equal to 2-3 months of taxes and insurance payments, into the escrow account. This is known as your escrow deposit or escrow funds.

• Each month a portion of your total mortgage payment will go toward replenishing the escrow account. This portion is calculated to cover your yearly property taxes, insurance bills and other fees.

• When bills come due, the lender will pay them directly from the escrow account on your behalf. This ensures these critical payments are made on time.

• Once a year, the lender analyzes the account and adjusts your monthly escrow payment if needed. This ensures there is enough money to cover upcoming bills.

So in short, an escrow account is a convenience account used by the lender to pay your homeownership expenses automatically. You don’t have to worry about budgeting for large quarterly or annual bills

Is an Escrow Account Required?

Whether an escrow account is mandatory depends on your mortgage program and down payment amount:

• Conventional loans often require escrow for down payments under 20%. Once you reach 20% equity, it may become optional.

• FHA and USDA loans require escrow accounts regardless of down payment size.

• VA loans do not require escrow accounts. They are optional.

If you’re applying for a government-backed or conventional loan with less than a 20% down payment, you can expect to have a mandatory escrow account. You usually only have a choice if you make a large down payment or qualify for a VA loan.

Now let’s look at the biggest pros and cons of opening an escrow account.

The Pros of Escrow Accounts

1. Your Bills Are Paid on Time

The #1 benefit of an escrow account is that your lender will handle paying your property taxes, insurance, and other bills on time. This protects you from penalties, late fees, and other headaches that come with missing payments.

As a new homeowner, keeping track of annual and semi-annual bills can be confusing. It’s easy to lose track and let something slip through the cracks. With an escrow account, the lender does all the work for you. They collect enough money from your monthly payment to cover your bills and pay them when due.

2. Your Monthly Payments Stay Consistent

Another nice perk is payment consistency. Instead of your mortgage jumping up and down each tax season, the fluctuating amounts are bundled into your escrow portion. This allows the overall payment to remain relatively stable.

Of course, your escrow payment can still change year to year as insurance and taxes shift. But having these variable expenses rolled in helps smooth out some of the bumps compared to paying them separately.

3. Account Shortfalls are Covered

If there is a shortfall in your escrow account, perhaps due to an unexpected tax hike, the lender will spot the difference. You don’t have to stress if the balance can’t cover an upcoming bill. The lender will make the payment anyway and adjust your monthly escrow contribution moving forward to make up for it.

This cushion provided by the lender is another way escrow accounts buy you some peace of mind. Temporary shortfalls won’t result in lapsed payments or angry tax collectors. The lender has your back.

4. May Get Better Mortgage Rates or Terms

Some lenders offer better mortgage interest rates or discounts on closing costs if you agree to open an escrow account. The account benefits them by ensuring timely payment of insurance and taxes on their collateral. In exchange, they pass on some savings to you.

So if you don’t mind having an escrow account, be sure to ask your lender if they offer any rate discounts in exchange! It could potentially save you money on your loan.

5. Integrated with Your Mortgage

Finally, integrating your escrow account with your mortgage payment can greatly simplify homeownership. You only have one payment to worry about each month instead of coordinating multiple bills and dates. It becomes a helpful “one stop shop” for your housing expenses.

The Cons of Escrow Accounts

Of course, escrow accounts also come with a few drawbacks to consider:

1. Large Upfront Deposit

When opening an escrow account, you’ll need to fund it with a lump sum deposit upfront. This deposit is usually equal to 2-3 months worth of taxes and insurance. It ensures the account has enough money from day one to start making payments on your behalf.

Coming up with this large deposit can be a challenge, especially for buyers short on cash. It adds one more big expense at closing. Just be prepared for this requirement.

2. Higher Monthly Payments

With an escrow account, your total monthly mortgage payment will be higher than just principal and interest. Now you’re also paying 1/12 of your yearly taxes, insurance, and mortgage insurance each month.

While this does help smooth out costs over the year, it does raise your base payment. Make sure you budget appropriately for the increased cash flow needed to cover a mortgage with escrow.

3. Loss of Interest

One downside is that money sitting in your escrow account isn’t earning interest like it would in your personal savings or checking account. The lender gets to hold and use those funds interest-free while they sit waiting to pay bills.

That said, today’s interest rates are very low, so you aren’t missing out on much potential earnings. But it’s something to keep in mind.

4. No Control Over Payments

Some borrowers don’t like the idea of the lender taking over payment responsibilities. You lose the ability to control when and how your insurance and taxes are paid. Some may also dislike not being able to access or invest the funds themselves.

Of course, you can still choose to make additional principal payments on your mortgage if you want to pay it down faster. But your escrowed expenses are on auto-pilot.

5. Possible Payment Issues

In rare cases, an escrow account runs into problems that could potentially lead to late fees. For example, if the lender makes a serious accounting mistake or goes bankrupt, payments could get missed or delayed. Most lenders are very reliable, but glitches can happen.

To maximize accountability, pick a reputable lender with a long history and reviews showing strong escrow servicing. This minimizes any risk of payment issues down the road.

6. Could Be a Scam Target

Unfortunately, fraudsters often target escrow accounts because they hold large sums of money. Be very cautious of any calls or emails claiming to be from your lender asking about your escrow funds or account details. Never send money without verifying the request through normal channels first.

Stick with a well-known lender and watch for warning signs of escrow scams. This will help protect your funds against theft or misuse.

Is an Escrow Account Right for You?

As you can see, escrow accounts offer some nice benefits but also come with responsibilities. Here are some final tips for deciding if one fits your situation:

• If your lender requires an escrow account, you don’t have a choice. It will be mandatory.

• If you struggle to save or budget for large periodic bills, an escrow can help you pay them seamlessly.

• If you want full control over your payments, dislike lump-sum deposits, or can earn more interest on your own, try to waive escrow.

• See if your lender offers discounted rates for opening an escrow account. That may sway your decision.

• Make sure you have strong defenses against escrow scams and fraud.

The bottom line? Escrow accounts provide valuable convenience and payment protection services for many homeowners. But they aren’t for everyone. Look at your own finances, preferences, and risk factors to decide if the benefits outweigh the drawbacks in your unique situation.

Whether or not an escrow account is “better” depends on individual circumstances and preferences. Escrow accounts, often used for mortgage payments, can offer convenience and ensure timely payment of property taxes and insurance.