To Escrow or Not To Escrow, That Is The Question

When preparing a refinance loan or purchase transaction, I often get asked, “Should I escrow my payments?”

Many lenders encourage borrowers to escrow their tax and insurance payments with their mortgage payment. The benefits to the lender are that they:

1) Know that your insurance will be kept active and in place, securing their investment in the event of an insurable loss.

a. Should your property burn down, they know they will be paid in full since most would not want to continue to make payments on a home that no longer exists.

2) Know that property taxes will remain current while they have a lien on the home, helping to ensure they have clear title.

a. If they must foreclose on the property, they want clear title and not to pay additional money toward incurred liens that can supersede their lien position such as property taxes.

3) The lender has additional funds in holding to issue loans while the money is awaiting its annual disbursement to pay property taxes and insurance.

a. Your property taxes and property insurance is paid annually, yet the lender has funds from your payment each month even though the tax and insurance bill is not due from them each month.

There are two ways lenders can encourage borrowers to escrow their payments:

1) They can require that your payments be escrowed. That usually nips it in the bud. This is often what occurs when your loan amount exceeds 80% of the value or sales price.

2) They can create an incentive for you to escrow your payment (or create a penalty not to escrow your payments). This allows the lender to cater to borrowers that demand they not escrow their payments, but a rate adjustment will be added.

For these reasons, you may be paying an escrow waiver fee up front of 0.25% of your loan amount, or your interest rate may be increased by approximately 0.125% by electing to escrow taxes and insurance now.

For some, the additional fee or interest rate is well worth the benefit. If you can get a 25% return on your money, then you would be losing by giving it to the lender on a monthly basis. For others, they realize that they would be financially better to keep the escrow money themselves, but prefer the peace of mind that they will not be struck twice a year with large invoices (taxes and insurance).

There is not a right or wrong way to determine whether you should escrow you payments, but my goal is to ensure that you are making an educated decision when you do decide.