Home insurance escrow: definition, how it works
- An escrow account is managed by your lender and holds your payments for property taxes and insurance.
- Escrow accounts are usually required by your lender if you have a mortgage.
- It’s a good idea to keep your home insurance even after you’ve paid off your mortgage.
Buying a home for the first time can be both exciting and overwhelming. It’s probably the biggest purchase of your life, and there’s a lot to learn along the way. Every step of the process – from securing financing, to finding the right location, to making an offer and closing the deal – is unknown.
One thing that might be new to you is the concept of an escrow account. If you take out a mortgage, your lender will likely require you to have one to ensure that you have enough money to cover related expenses, including
What is a home insurance escrow account?
Your real estate agent will usually open an escrow account with your lender for you at closing. This is a separate bank account that consolidates your mortgage, property taxes and insurance payments, including your
premiums. An escrow account will transfer your payments to one account, so you don’t have to worry about paying various bills each month. It also ensures that you will have enough money to cover lump-sum home insurance payments and property taxes when they come due.
Most lenders will require an escrow account. For example, if you have a mortgage from the Federal Housing Administration (FHA) or the United States Department of Agriculture (USDA), you should create an escrow account. However, you will only need an escrow account for a conventional mortgage if you earn less than 20%.
. When it comes to VA mortgages, many VA lenders need them, but not all.
The amount you pay into your escrow account each month will vary based on the cumulative annual expenses of your mortgage, property taxes and insurance premiums. You calculate your monthly escrow payments by adding up your expenses and dividing the sum by 12. However, many lenders may require an escrow cushion, an excess amount above your mortgage payments, to ensure that you have enough funds. The cushion, however, cannot exceed two monthly escrow payments, depending on the Consumer Financial Protection Bureau (CFPB).
Advantages and disadvantages of home insurance escrow account
While a home insurance escrow account can be beneficial, it also has several disadvantages. Whether or not you have the option of using one, determining whether a home insurance escrow account is right for you is critical because it can be difficult to get rid of if you change your mind, says Dan Belcher, CEO of Mortgage relief.
The benefits of an escrow account depend on whether you want to be more independent with your monthly payments or whether you value the agency over your account.
5 Steps to Create a Home Insurance Escrow Account
There are instances where you can decline to have an escrow account with your lender. Know that you are responsible for paying your expenses on time, often in a lump sum instead of monthly installments.
“The benefit of using an escrow account to pay for your homeowner’s insurance is knowing you can be sure the payments are being made,” says Maria Townsend, North Carolina Licensed Insurance Broker and CEO of Stash assured, an insurance education platform. “However, consumers can also pay annually without escrow, if they have a substantial amount for their down payment on their property.”
Here’s how to set up an escrow account yourself:
Step 1: Check your total insurance bill and tax bill for the year
Checking your total annual bill will determine the amount you need to deposit into your escrow account monthly. Insurance companies may ask you to pay quarterly or every six months instead of once a year. Contact yours to determine the exact amount you need to pay and when your payments are due. Likewise, you want to contact your local tax collector for payment dates and amounts. You may be required to pay quarterly, every six months or annually.
Step 2: Calculate your monthly payments
Add your annual insurance premiums and your property taxes and divide the sum by 12. This amount is the amount you will pay into the escrow account each month. Since property taxes and insurance rates can fluctuate, you may want to include a cushion to avoid any shortfalls. This way you can avoid late fees and penalties.
Step 3: Open an account
Contact private banks and
to inquire about escrow account options. Have your contact details and information about any other parties applying for the account handy. Alternatively, you can put your monthly property taxes and insurance payments into a high-yield savings account to earn higher interest on your money.
Step 4: Automate deposits and withdrawals
Like an escrow account managed by your lender, it’s a good idea to automate your deposits to ensure you have enough funds in your account. Likewise, you should automate your withdrawals from your account to your insurance company and tax department, so you don’t default on your payments and avoid late fees. Note that if you set up an escrow account with a bank, your bank will handle the payments for you, but may charge a fee for this service.
Step 5: Adjust your escrow or bank account throughout the year
Be sure to monitor your account to reflect any changes throughout the year. Property taxes and insurance premiums fluctuate, and you want to make sure you have enough money to pay your bill.
Should you keep your home insurance policy after paying off your mortgage?
Although not required by law, keeping your homeowners insurance policy after you pay off your mortgage is a good idea, says Townsend. Home insurance protects your home and personal property against damage. It can also protect you from liability if someone is injured on your property.
The last thing you want is to suffer an unexpected loss related to your home and not be able to afford the replacements. Insurance is there to help you prepare for the worst and mitigate the financial hardship of a home-related loss, especially if you live in a high-risk area.
How to change your home insurance with escrow
If you want to switch to another home insurance provider when making payments through an escrow account, it’s important to update your mortgage lender with the new information.
After comparing quotes and making the switch, you’ll need to submit the lender’s mortgage clause information to your new insurance company, and their insurance advisor will send the proof of insurance, Townsend says.
It usually costs nothing to change your home insurance, but the insurance company may have cancellation fees if you decide to suspend your policy. Also take note of any shortfalls or overruns in your monthly payments during the transition period, as your monthly mortgage payments may change.