How to Break Free from Your Escrow Account
When my fiancé, Paul, and I bought our first home last September, a co-worker of mine asked if we were going to use an escrow account or not. After shelling out tens of thousands of dollars, the thought of owing large tax bills in just a few months in the New Year made an escrow account an appetizing option. Besides, as a first time home buyer, I was not fully knowledgeable with how the entire home buying process worked, so when we found out that most new home buyers use an escrow account, we chose to go with the flow and do so as well.
Now that we’ve had the chance to burn a few fires in our fireplace, plant our fall crop (we live in Houston, TX), and have a party or two with our new grill, we are taking the time to reassess and fine-tune bills associated with our home. By shopping around for homeowner’s insurance, we were able to get comparable coverage at a whopping $739 less than the plan we originally signed up for.
With such a great savings under my belt, I thought I would next tackle the escrow account, and share with you the benefits of not having one, the conditions you must meet to get rid of your own, and how to make sure you can still pay your homeowner’s insurance and taxes each year.
Benefits of Losing the Escrow
The first benefit is being able to use your money to earn money for you. By paying a mortgage company an extra several hundred dollars each month, you are giving them an interest-free loan (which they are using to earn themselves money) until your insurance premiums and property taxes are due each year. Instead, you can put that money into a savings account, or buy a six month CD, and earn interest for you. Here’s an example:
- Let’s say you need $4800 by the end of the year in your ‘escrow’ account. You save $400 per month into an online savings account, such as ING Direct, with a current interest rate of 1.3% apy. After 12 months of saving $400 per month, you will have earned yourself $33.22. May not sound like much, but if you do this for the life of a 30 year loan, your return would be $996.60. (And let’s hope the interest rates on savings accounts go back up during that time, giving you an even higher yield!) Would you rather that $33.22 per year go to your bank, or to you?
Another great benefit of losing your escrow account is that you can now pay your homeowner’s insurance premiums on your credit card. Charge it to a cash back rewards card, or to a credit card with points/frequent flyer miles/etc., and you have given yourself a discount on your taxes. Just make sure you pay off the balance before incurring any finance charge.
Meeting the Requirements
As far as your lender is concerned, here are the typical requirements you usually must meet to eliminate your escrow account:
- Your mortgage is at least one year old, and you have made on-time payments consistently for the entire year
- LTV (loan-to-value ratio) has to be under 75%
- Loan has to be a conventional loan (VA and FHA loans typically cannot shed their escrow accounts; it is part of the condition of a government-backed loan)
- No taxes or insurance payments can be due in the next 30 days
Please note that lenders vary somewhat in their conditions, so you need to call yours up and ask them what conditions need to be met.
Making the Payments Each Year
Finally, probably the most important requirement of not paying into an escrow account is to be self-disciplined in your saving habits. Create your own escrow account using an online savings account, such as ING Direct, and pay into that account each month the amount that you need in order to cover your homeowner’s insurance premiums, flood insurance premiums, and property taxes each year (see example above). It is best to have this money automatically withdrawn from your checking or paycheck each month so that you do not think about it as much.
Make this account untouchable in your mind. You do not want to be sent a bill for several thousand dollars when you have already tapped your ‘escrow’ account for something else earlier in the year.
Yup, back in 2001, with our first (and so far only) home purchase, we got an 80/20 piggyback loan. No escrow for us. Property taxes were due a year later. Glad we never did escrow. Never really dedicated a monthly amount to it, just planned to have the amount by the time it was needed based on our available money in savings. At work, most people that I speak with about it, have no clue how much they pay in property taxes, because it is escrowed for them.
Great idea – why give the mortgage company an interest-free loan?
However, many mortgage companies will charge you an extra interest rate bump if you do not escrow with them – and agree to keep the excrow with them. In fact, in my area (Chicago), from having consulted with two loan brokers and and several loan companies, it seems like the loan companies with the lowest rates insist on the escrow (they are making some of their money back with the escrow). In this regard, note that 25 basis points on a $200K loan costs you $500/year. Conversely, the interest on an escrow with a $3000 average yearly balance at current money market rates is about $30. In this analysis, you would probably want to go with an escrow.
However, I note that this is one of the heavily regulated areas and that states often vary in what they allow lenders to do. For example, your state may not allow a lender to make you having an escrow with them a contidion of the loan. In this case, the lender is probably already pricing in the additional 25 basis points, so you miss out on a discount. If people sometimes wonder why interest rates vary from state to state, part of it is due to little regulatory nuggets like this.
wrc1000: Good for you! Thanks for the comment. I guess if you escrow, you almost feel like it is all mortgage principal and interest. I am sure most people don’t sit down and figure out their property taxes and monthly insurance costs (if they did, they might contest their appraisal, or call insurance companies to get a better quote).
Managing Partner: Thank you for the information! I did not know that about Chicago, and I am sure that is the case elsewhere also.
Amanda, I’m curious as to why dropping escrow allows you to begin making payments on a credit card. Could you elaborate a little more?
Dropping the escrow is the way to go, if you actually care about your own finances. Paying the property taxes and the home insurance out of our own pockets is great practice for the day in the near future when we plan to be mortgage-free (at which point escrow becomes obsolete).
Edwin: Sure! You can pay your home insurance with a credit card, and then pay that off before the grace period ends. By doing that, you can gain reward points on potentially $1,000+ (depending on how much your home insurance is). I am not sure if property taxes can be paid by credit card…I want to say probably not, but definitely check into it. If so, there are more reward points you can earn by not having your money in escrow. Ofcourse, if you know you cannot pay off the entire payment by the end of the grace period, then that negates the reward points earned because you will owe a finance charge.
Thanks for the question!
Executioner: Ahhhhh–mortgage-free! What an exciting thought:). Thanks for the comment.
The choice to use an escrow account is left up to the local jurisdiction. In my county and state, I don’t know of any law that makes it mandatory to let me handle my own escrow. When I asked about it for the last two mortgages, I was told it would cost me an extra 1/4 point for that privilege.
Obviously, these banks don’t want me to earn interest on my money. They want to keep it.
Great piece and I did not realize that you could “take back” your escrow account. Definetly makes sense to use it for your benefit than the interest free loan to the bank. You may have just saved my some money here.
Grown-ups do not need somebody else earning interest off of their own money. The internet is littered with stories of escrow companies folding and not paying taxes and insurance.
You state that “Another great benefit of losing your escrow account is that you can now pay your homeowner’s insurance premiums on your credit card.”
I am not so sure everybody can pay by CC; this is possible only for those whose mortgage comp. actually accept CC payments. Am I wrong?
Hello FV: Thanks for your comment! It is your homeowner’s insurance company (not your mortgage company) that will need to accept credit card payments. However, I am sure most, if not all, do accept credit card payments.
Thanks for the info! I’m a fist time home buyer as well and my aunt keeps telling me that canceling your escrow account and paying taxes/ins. yourself will save you money. This is just the info that I needed!
what about new jersey jurisdiction for escrow account , I realy need to eliminate this account, specially with this high real estate taxes in new jersey which consider as double your mortgage payments
Fourteen states require lenders to pay interest on their escrow accounts. I’m earning more on my NY escrow account than I could get from any online bank so I’m not going to close mine anytime soon.
Very interesting. Thank you for sharing that information. I guess Texas is not one of those states? (that’s where we live).
Which states pay interest on Escrow accounts? Do you mind sharing that info, please?
i fell behind four and a half months on paying my property tax. I only owe a third of what my house is now worth. I payed everything up in June and now they want me to pay them 3,800 towards an escrow account plus a higher mortgage. I had a mortgage with country wide but Bank of America took over my mortgage and is now screwing me
Keep the escrow. How ridiculous. Less than a thousand dollars over 30 years. Small price for a piece of mind. Its a lot better than not being able to pay your taxes one month due to an unforeseen circumstance and losing your house. If saving 30 bucks a month is changing your life, then owning a house should be the last thing on your list.