Build Your Escrow Account Buffer
When you take out a mortgage, lenders usually require you to create an escrow account. When you pay your mortgage each month, your lender will deposit a portion of your payment into this account. Your lender will then use the funds in this account to pay your property taxes and homeowners’ insurance bills on your behalf when they come due.
How much you pay each month depends on your taxes and insurance costs. If you pay $5,000 a year in property taxes and $1,000 annually for your homeowners’ insurance, you’ll pay $500 extra each month – $6,000 divided by 12 months -- that your lender will deposit in your escrow account.
This ensures that you’ll always have enough money to pay these two key bills.
Starting your escrow account at closing
When you close on your mortgage, you’ll pay a series of closing costs to your lenders and other providers such as your appraiser, title insurer and real estate lawyer. A significant portion of your closing costs will be allocated to the initial funding of your escrow account.
While your lender will collect money with each mortgage payment for escrow, it also needs to ensure that you have sufficient funds in your account to cover any upcoming insurance or tax bills. To ensure this, they’ll require that you pay a buffer at closing, an immediate deposit into your escrow account.
How much you pay depends on your estimated tax and insurance bills. It varies, but lenders typically require buyers to deposit from two to nine months of monthly property tax payments at closing. Say your lender expects your property tax bill to be $6,000 for the year. Your lender will divide $6,000 by 12 to get a monthly payment of $500. If your lender requires that you pay six months of property taxes as an escrow buffer, you’ll need to provide $3,000 at closing.
Lenders will also require two to three months of homeowners’ insurance payments. Say your homeowners’ insurance costs $1,200 per year. That figure divided by 12 equals a monthly payment of $100. If your lender requires three months of insurance payments for your initial escrow payment, you’ll need to provide $300 at closing.
In this example, then, you’d pay $3,300 for your initial escrow payment at closing.
Can you avoid escrow?
Can you refuse an escrow account and make your insurance and property tax payments on your own? Maybe. Most mortgage lenders require escrow payments because they want borrowers to make these payments on time and not forget or miss them. If borrowers do, their insurance companies or government taxing bodies could place a lien on the home.
If you do find a lender that will allow you to skip escrow and make these payments on your own, be careful never to miss an insurance or tax bill. A lien could ultimately result in you losing your home. Work with qualified real estate and financial professionals to make sure you're handling your payments correctly.