Setting up an escrow account makes good sense when you buy a home. It helps you to save money, so you can easily pay for taxes, fees and other financial obligations tied to your home. But how does home insurance work with escrow?
What Is an Escrow Account
When you close on your home, your mortgage lender will often set up an escrow account for you. An escrow account helps you save for all the financial obligations you have other than your monthly mortgage payment.
Here’s how it works. Each month, a significant part of your home payment will go toward your mortgage to pay your principal and interest. The other part will go into an escrow account, if one has been set up.
- Mortgage insurance
- Homeowners insurance
- Flood insurance
- Property taxes
- Administrative fees
- Homeowners association fee
From your escrow account, a single monthly payment is automatically made to your lender to cover your mortgage insurance, homeowners insurance and, potentially, other related bills and fees. This way, you don’t have to save for these things separately.
How Home Insurance and Escrow Work Together
An escrow account is simply an account into which money is deposited to cover specific bills for your home. One of those bills is your homeowners insurance premium.
It’s important to note that an escrow account has no impact on the rate of your homeowners insurance. In other words, it doesn’t make homeowners insurance more or less expensive.
The best way to lower your homeowners insurance premium is to get quotes from other carriers so you can compare prices. You can also lower your premium by raising your deductible and by taking advantage of any discounts that your home insurance carrier may offer.
Do I have to pay homeowners insurance through escrow?
If the down payment on your home was less than 20%, it’s possible that your lender will require you to establish an escrow account to pay your homeowners insurance. This ensures your home insurance premium will be paid on time every month with no lapse in coverage. It also helps protect the lender’s investment in your home.
How is my escrow payment calculated?
To figure out your monthly escrow payment amount, lenders estimate how much your property taxes, homeowners insurance and other home-related bills will cost over the next 12 months. That estimate is then divided by 12.
For example, if your yearly property taxes are estimated to be $3,000 and your yearly homeowners insurance is $1,500, that’s a total of $4,500 for the coming year. When that figure is divided by twelve, we get $375. Therefore, $375 will be the escrow portion of your total monthly mortgage payment.
Does my escrow account require a minimum balance?
Yes, it does. This is because your total payment can change from year to year due to fluctuating home insurance premiums and property tax amounts. To help you prepare for these potential increases, you need a minimum balance in your account at all times. Your lender will determine the minimum amount, which can be up to two months of escrow payments.
Pros and Cons of Using Escrow for Home Insurance
Like most things, there are both pros and cons to having an escrow account.
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PRO: It’s convenient
With an escrow account, you don’t have to keep track of the incorporated bills if you don’t want. In fact, you don’t even have to think about them. That’s because your escrow account pays them every month.
PRO: It’s automatic
If you’re someone who waits until the last moment to pay bills, you’ll love having an escrow account. Your property tax and homeowners insurance payments will be paid on time, every month—automatically. You’ll never miss a payment or pay late fees.
PRO: Peace of mind
Escrow accounts make life a lot easier for homeowners who want to add predictability to their monthly expenses. Even if your home insurance premium or property taxes fluctuate during the year, your escrow account will pay those bills on time—so you can rest easy.
PRO: Potentially lower mortgage costs
Depending on your mortgage lender, you may be able to get a discount on your home interest rate or closing costs just by having an escrow account.
CON: Large upfront deposit
Many escrow accounts require homebuyers to first deposit an amount equal to two to three months’ worth of property taxes and home insurance premiums. This kind of a cushion is designed to cover unexpected expenses.
CON: Less control of your money
In theory, the money in your escrow account is tied up, so you can’t use it for short-term investments. You will need to weigh that against the security of knowing that your property taxes and homeowners insurance premium will always be paid on time.
CON: Possibility of incorrect estimates
The amount that needs to be tucked away in your escrow account hinges on your home insurance premiums and property taxes, which can vary year-to-year. Generally, the previous year’s bills are used to figure out how much you’ll need, but incorrect estimates can happen.
CON: Potential target for scammers
Your escrow account can be an attractive target for fraudsters. As always, be careful who you give your personal information to online.
