NATALI MORRIS

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Natali Morris Blog

June 3, 2016

Why You Should Not Escrow Your Taxes And Insurance

We recently refinanced a mortgage and somehow in the raping of many trees, I overlooked the page that allowed me to choose whether or not to escrow my taxes and insurance into my mortgage payment. If I had caught that page, I would have OPTED OUT but I guess my head was in the clouds that day.

If you are new to mortgages, here is what I’m talking about: Your monthly mortgage payment includes a principal payment plus amortized interest. The mortgage company usually gives you the option of paying a few hundred dollars extra per month so that they can keep that money in an escrow account to pay your annual property taxes and homeowners’ insurance. Isn’t that so kind of them?

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Well, not really. They do not do this because they are kind. They do it for two reasons:

  1. They are CYA‘ing. If you do not pay your property taxes, the city will take priority in a lien against the house (in most states). This means that if your house has to be sold at auction or foreclosed on, the city will get paid back first before the lender. The lender has no guarantee of being repaid in full. They get whatever scraps are left over from the emergency sale. The lender obviously doesn’t like this option.
  2. They are also making money on your escrow account. Let me explain this.

I am not a lender so I am not 100% sure that the lender earns interest on your escrow account, although my insurance agent assures me that they do. But I do know that they do not have to pay YOU any interest whatsoever so you could be keeping thousands of dollars in this account per year, earning ZERO on it. Plus, they pad this account to make sure they have enough for these bills. The law allows them to estimate the total of taxes and insurance and add 1/6 more.

With this high cash reserve from your escrowed money, the bank can now lend out more money and make more money on those loans based on our system of fractional reserve banking.

I live in a very high property tax rate county. Taxes for homes in my area are regularly assessed at $20,000 per year. So do the opportunity-cost math for where you should put that $20,000 before it comes called up by the tax man.

Some interest-bearing account > 0 interest-bearing account

In some cases, the lender requires you to use an escrow account and charges you a one-time set-up fee to boot. But often you are given an option and if you are given the option, I suggest you opt out in the interest of maximizing the power of your dollars! Have the discipline to save this money yourself, put it in an interest-bearing account, and then you’ll have some extra dough left over to ease the pain of your tax bill.

Since I had neglected to do that on my recent refinance, I had to request to opt-out after the loan had closed by sending an actual fax. So old school! (Incidentally I do this with an iPad app called iFax. Comes in handy from time to time.)

Thankfully I really like our lender and they were super cool about this request. They dissolved the escrow account within a week and sent me a refund for the money they had been holding in there. My insurance agent was shocked that they were so breezy about it.

“If you were with Wells Fargo or one of the other big banks, I doubt they would have let you do that,” she said. “It’s getting increasingly hard to get the banks to give up a single penny because interest rates are so low and they are not making enough money on their loans.”

She makes a point!

She cautioned me that when that tax and insurance bills shows up, I should pay them pronto because if the bank gets an opportunity to pay it, they’ll jump at the chance to escrow me up again. Not sure if that is true but okay.

What about convenience?

I grant you, an escrow account is convenient. If you have not saved enough in taxes and you get that ugly bill in the mail, it puts a world of hurt on. And your property tax bill isn’t something you can affect very much, other than arguing with the city about your home’s value. For the most part, the government digs its heels in and makes you pay what they demand. Same with insurance bill. The cost is the cost and it is usually a high cost for homeowners.

If you really think you need to be forced to save this money inside of an escrow account, I applaud you for knowing the extent of your willpower. But if you are trying to play the smartest you possibly can with every dollar you spend, you already know the logical choice.

One last note of caution: Your lender does not know for sure how much your taxes and insurance for the next year will be. The city assesses tax values annually and your insurance rate can change too. Your lender estimates this amount and then pads the number in the escrow. They are required to disclose this to you. Look for this in your statements and make sure they are not holding too much of YOUR money.

Okay I’m done on this subject. Would love to hear what any experienced lenders have to say about this! You know how to respond so do so!

 

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21 responses to “Why You Should Not Escrow Your Taxes And Insurance”

  1. RedwoodCitytoNJ says:

    If some folks have a tendency to pay their bills late the penalties on missing a property tax payment is greater versus opportunity cost. I selected to have my property taxes put in escrow, but not my insurance. With low-interest rates, the upside is limited. Not worth the risk.

  2. Ron B says:

    Some comments:

    A. You should never be charged an escrow set up fee. On the contrary, in most states, you are charged to waive an escrow account on Fannie Mae and Freddie Mac loans.

    B. I agree with RedwoodCitytoNJ… the small amount of interest you may lose does not compensate for the convenience of making one payment to cover PITI.

    C. A law was recently passed that actually requires an escrow account for flood insurance.

    D. For most people, I advise an escrow account. For those that use a HELOC to pre-pay their mortgage, I advise not to as the HELOC can come in handy for those payments when they come around and especially in high tax states such as NY & NJ.

  3. Tom P says:

    My parents taught me to always avoid escrow accounts like the plague. On our current mortgage we opted out of the escrow. But now we are looking to refi and most of the banks we are talking with will add 1/8 point if we don’t want to escrow. That is a big upfront cost that would fund most of our initial escrow balance and it would be nice to not have to worry about property tax payments twice a year.

    On your situation, I don’t think having your bank release your escrow funds is very common. It is an additional risk that they will be bearing so there is some associated cost, hence the additional upfront fee that we will be charged.

    Agree with Ron, for most people, I think escrowing is probably a good idea.

  4. Chris says:

    There is another advantage of managing tax payments for yourself. In California they automatically allow you to make 2 separate payments for your property tax. The first is due in December and the second the next year. Should you have a windfall in income one year, you can pay ALL of that year’s property taxes by December so you maximize that deductible expense.

  5. Tim says:

    We just happened upon another very good reason to leave your money in the bank: escrow accounts are NOT INSURED.

    If your escrow company receives a fraudulent or erroneous bill, and they pay it on your behalf, you might get screwed.

    In our case, PennyMac (might as well name names) received an erroneous insurance bill for our address, because the previous owner failed to cancel his policy (and just happened to have the same lender).

    Rather than ignoring the bill, PennyMac paid it out of our escrow account (assuming we’d changed insurance companies… and our name… apparently). When we asked to have the money refunded, PennyMac refused. After being passed around to different people over a couple days, I was eventually told (by someone who sounded like their attorney) that PennyMac was NOT a bank, that they were NOT FDIC insured, and that they were under NO obligation to replace any funds that they been erroneously paid on our behalf. Nice. If we wanted our money back, we’d have to contact the insurance company they had paid.

    Naturally, if we’d received the bill ourselves, we never would’ve paid it. When you have someone else paying your bills, there’s a chance that these kinds of errors can occur, and the escrow holder may not take responsibility for their mistakes.

    After many calls and several months of hassle (and having to prove to the 3rd party insurance company that the home HAD been sold), we eventually received a refund. Had this been a fraudulent bill, we would’ve been out $1000. And even though we received a refund, it was still a pain to resolve.

    • nmorris says:

      Holy cow, really!? That sounds like a huge headache! I had no idea that was not an insured account. Total crap!

    • Daniel says:

      That is not possible. If the lender made a mistake, they are required to fix it. If they refuse to fix it, you have a few options. First, file a formal complaint with the CFPB at Consumerfinance.gov

      Second, get an attorney.

      Once an institution escrows, they are liable for the funds and what they do with the funds. If they paid your taxes late, the lender is required to pay the fee. If they pay the wrong property tax bill, the lender will need to pay yours while they wait to get the wrong payment refunded. There are rules and regulations in place for this reason.

      https://www.fdic.gov/consumers/consumer/news/cnspr11/escrow.html

      Yes, lenders are not FDIC insured. In fact, even if your lender was FDIC insured, your loan isn’t.

  6. J. River says:

    First let me say thank you for writing this article, Natali!

    Second, first time home buyer here so when I received a notification that I would be receiving a refund from my escrow account I was thrilled. But due to couple of earlier financial mistakes I decided that I needed to intelligently approach this surprise money (it’s almost as much as a full mortgage payment due to the appraisal value changing).

    So what do I do with it? Thank god for google. After a fairly lengthy search (who am I kidding, most of us millenials give up if it’s not one of the top 3 results on the first page) and a few tabs worth of bank propaganda later I came across this article. Your situation and exposition taught me several things I knew nothing about previously but had been seeking answers on.

    Now, thanks to your effort, I will be able to more intelligently and affectively approach my escrow refund.

    Regards,
    J. River
    A Millennial

  7. Amy Tang says:

    I really appreciate the insight here in this post and confident it’s going to be helpful to me and many others. Thanks for sharing all the information and tips.

  8. Anne says:

    Your article was interesting as I am trying to determine if I can change my mortgage and NOT have my property taxes and insurance escrowed. My property taxes are so high and they are split into two payments annually. The lender just raised my mortgage payment by 125.00 which is enough to cause me a huge budget issue, if not a reason to move altogether because the payment is jut too high. I’m a long time homeowner, meaning this is my fourth home over a 25 year period and I’ve never experienced such fluctuations from year to year in my mortgage payment. It seems that two things are happening: they are padding the amount by a large percentage and secondly, they are calculating it wrong! I put nearly 30% down on this house and have lived here a little over two years. I no longer want them “managing” my money so how do I eliminate the escrow? My insurance isn’t changing and my property taxes went down just in May due to the classification of my home from being a rental property before I purchased it and now it’s a primary residence. The Homestead Act it is??? So that change, coupled with ILLINOIS taxes historically being paid in arrears in this county, my payment was high for over a year and a half after moving here until the county finally issued the new property taxes, meaning mine dropped by about $800. So, it really doesn’t add up how I can possibly have a shortage in my escrow to begin with. I don’t know if a call to them is warranted or if I can just eliminate the escrow. Advice on all of this????

  9. Anne says:

    I might add that I am an artist, a small business owner, so my income fluctuates thru outhe each year, meaning there are months I have a windfall and could simply pay the taxes and/or insurance sooner or in full.

    • Anne, a belated thank you for this note! And OUCH! This increase in your payment sucks!! Have you called your bank and asked them to uncouple your taxes and insurance? They don’t all allow it but it is worth checking into. I had a bank that allowed it but I had to fax (FAX!?) my request in and wait weeks for an answer. Good luck with this!

  10. Gee Cory says:

    I have an FHA loan…so I can’t get out of my escrow account. I got tired of this “escrow shortfall” issue coming up year after year… So, what I did do last year was start paying my own taxes and insurance WELL BEFORE any bill went to the mortgage company. The result? For the first time there was a SURPLUS in my escrow account…and they, not only had to refund the money (what I had paid and then some,) but my mortgage payment went down. Yes…for the year I basically paid double…but I got the money back… and the end result was that there could be no “escrow shortfall,” and thus, no increase to my monthly mortgage payment. The money they refunded to me will simply be used to do the same thing… pay my own tax and interest.

    • Oh that’s clever! I’m surprised they let you do that! Can I ask you for clarification: How did you make sure that your mortgage holder wouldn’t pay those bills too? You paid them WAY in advance so no bill was sent? Did you call the tax and insurance offices to make sure of that? I would think that they would still send a bill and then the mortgage company would pay it anyway. And how did they drop your mortgage payment if you are still required to have an escrow account? They can’t guarantee that you’ll pay both next year, right?

    • OP says:

      Gee Cory, I have been looking for someone who did what you did as I’ve been thinking of doing exactly the same, so thank you for your post! I also suffer from my mortgage company miscalculating my taxes, but I have a VA loan and they require an escrow account. Not only will this allow me to better manage my money throughout the year (and earn some interest while I wait for these yearly bills), but I can also pay my taxes and insurance with a credit and earn rewards cash (and pay the credit card balance off, of course)!

      Along with the questions from Natali Morris, how did you know that your mortgage company would refund you the money? Are all lenders required to refund money collected if the bill has been paid already? I haven’t been able to find the answer to this so any insight you have is appreciated.

  11. Shaimpy says:

    Hi OP, I got mortgage of 2650 per month with an escrow account. In July 2016, I did that accidently . I went on the county accesor’s website and saw a bill so i paid 1100 usd in july that year with my credit card my mortgage payment went down to 2595 in sep 2016 and by the end of that year i got a check from my mortgage company for 1100 usd but in Jan 2017 my mortgage jumped to 2800 due to a shortfall in an escrow account. I called the mortgage company and ask them the reason and they said its due to a shortfall in my escrow account and i have to keep paying it it it get balanced. They were unable to answer my question about how long i have to keep paying it. So honestly, even with escrow account banks can jack up your mortgage payment. My advice, if you are good with math, then calculate your monthly escrow payments, add another 1/6 amount on top of that and save in your saving account. Pay your escrow account with credit card and then pay the card back.

    • I’m not sure I understand this. You paid the tax bill yourself but still had a deficit in your escrow account? And you pay your escrow account with a credit card? How?

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