A few years ago I announced that my wife and I had paid off all of our student loan and car debt. So except for the mortgage, we’ve been able to remain debt free, which I think is pretty good for living in Southern California where real estate is pretty pricey.
I have used USAA as a mortgage lender in the past, but have been with Quicken Loans for a few years now. They were able to lock me in with a very low interest fixed VA jumbo loan. Both of the lenders required that I have an escrow account.
A Primer On Escrow Accounts
An escrow account, as you may already know, is used to pay for property taxes and insurance. Since mortgage lenders have an interest in your property until you pay off the loan in full, they want to ensure that you keep up with your tax and insurance payments.
Payments to the escrow account are built into the monthly mortgage payment and are set aside until the property tax and insurance payments are due. The lender receives a copy of the bills and then schedule payments on your behalf.
Some people like it because they don’t have to worry about being disciplined enough to set aside the money to make their payments each year or on-time. Some people hate it because they want to have control of their money, and would rather manage the cash flow themselves. I’m kind of in-between.
In terms of managing cash flow, I don’t really care if I have to make an extra payment to an escrow account on top of my mortgage payment. I would essentially have to do the same thing myself by diverting the money to a savings account anyway. The money would just sit there all year in a low yielding account (even if they say “high yield savings” right now), until I had to make the payments.
The Escrow Account Analysis
The part that I hate is the annual escrow account analysis. This year, Quicken Loans changed when they do their analysis to better match up with payment due dates for property taxes and insurance. It makes sense, and I wonder what took them so long to take action. The problem is, they can’t seem to get it right.
Just a few months ago, they sent a refund check for about 75 bucks because there was an “account surplus” in my escrow account. And now, not three months later, I get a new analysis statement in the mail stating that there will be a shortage in the account.
Not only will my monthly payment increase to account for higher property taxes, but I have to write them a check for 575 dollars to increase the minimum balance required in the account. If I don’t send the lump sum, they will increase my monthly payment even more to account for the difference.
It’s not a big deal, but they could have thought this through before sending a refund and wasting man hours and money on a needless transaction. And in our own consumer interests, having an escrow account means that your monthly mortgage payment covering your principal, interest, taxes, and insurance (PITI) will vary from year to year. That may not sit well with folks who have a fixed rate loan and are expecting fixed payments for the life of the loan. Keep in mind that if you have a fixed rate loan, your principal and interest payments will be fixed – it’s the taxes and insurance portion that fluctuates.
So here’s the part that’s not so bad about having an escrow account. In California, it’s my understanding that escrow accounts must pay an interest rate of 2%. That means that your mortgage lender must pay you interest on the money they hold on your behalf to make your tax and insurance payments. Where else can you get that kind of interest rate in a short-term savings account these days? You can’t even match 2% with inflation protected government I-Bonds right now.
So should you save more money in an escrow account to take advantage of the interest rate? The answer is, you can’t. Lenders have guidelines and laws to abide by, the Real Estate Settlement Procedures Act or RESPA, when administering escrow accounts. There is an upper limit to the balance you can have in the escrow account based on the property tax and insurance payment that you owe each year. If the amount of money you have in the escrow account goes above that limit, your lender will send you a refund check.
Pros And Cons
So, there are some pros and cons to having an escrow account. The laws that are applicable based on where you live, whether you have a low income or are a high earner, the amount of your mortgage, the requirements of your lender, and your financial habits are all factors that contribute to the decision if an escrow account is right/required for you.
Do you live in a state that requires interest payments on escrow accounts? What do you/don’t you like about having an escrow account?
If you don’t have an escrow account, do you have any tips on how to save the money for your annual property tax and insurance payments? Or how to earn a better return?