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The Reason We Escrow Taxes and Insurance

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escrow taxes and insurance

Banks often have specific requirements to reduce the financial risks involved with offering a home loan to mortgage borrowers. One of these conditions may be to escrow taxes and insurance on your mortgage.

What does it Mean to Escrow Taxes and Insurance?

A mortgage escrow is mainly the account that is used to pay your homeowner property taxes and insurance. When you escrow mortgage taxes and insurance, you agree to pay the mortgage lender your monthly mortgage amount along with the monthly amount due for taxes and insurance and also allow the lender to pay your mortgage and insurance payments on your behalf. This sum is collectively called the PITI: the principal, interest, taxes, and insurance.

What is the Purpose of a Mortgage Escrow?

Mortgage escrows offer banks or lenders the security of knowing that your property taxes will not go unpaid and that your property insurance will not lapse. If the coverage is inadequate, the property will not have any protection against potentially costly damage, and if a property tax bill goes unpaid, the lender could risk losing the home entirely.

Here’s how this could happen:

If a mortgage payment is overdue, the lender may place a mortgage lien on the property and will reclaim and retain the ownership. If however, the property tax bill is also unpaid, the property will be subject to a tax lien by the county government. Tax liens are the only type of claim that will supersede a mortgage lien putting the lender at risk of losing the property as well as the defaulted payment amount.

Are There Any Benefits to The Borrower?

With so much at risk, it makes sense that banks and other types of lenders will want to protect their assets, but when you escrow taxes and insurance, you will find that there are benefits for the mortgage borrower as well.

To begin with, you may qualify for a lower mortgage rate than without escrow. Since your escrow reduces the lender’s risk, they usually will offer the most economical interest rate as an incentive for agreeing to escrow. Offering that incentive rewards the borrower while protecting the bank.

Secondly, when you set up your escrow account, you do not have to worry about paying your hazard insurance bills or your property tax payments since the lender will make those payments for you.

Thirdly, it may ease the financial burden of home ownership by splitting your payments over a monthly cycle rather than having to pay large chunks of money for property taxes twice a year.

Should You Choose Escrow on Your Mortgage Loan?

In most cases, mortgage escrows are an excellent option for both banks and homeowners and in some cases are mandatory. For instance, all loans insured by the Federal Housing Administration must escrow taxes and insurance.

Escrow accounts offer protection to homeowners as well since mortgage lenders are required to submit detailed reports on each account and lenders are not allowed to withhold more than the agreed-upon sum otherwise it must be refunded to the borrower.

It may also be an excellent idea to escrow taxes and insurance just because often the borrower is charged an extra fee or a higher mortgage rate if they do not opt for escrow due to the added risk imposed.

This article is a part of our “Real Estate 101” series of posts.  Click here to learn more.

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