What Is “Escrow”, And Do I Need It?

I did a transaction recently where the buyer decided not to establish escrow.  Why would a buyer decide to do this?

The truth is I don’t know … I don’t mean he was wrong to do it, I just mean “why would a buyer decide to not set up an escrow account?”.

When you establish an escrow account with your lender, each month your mortgage payment is divided in to four parts:  (1) Principal, (2) Interest, (3) Taxes and (4) Insurance.

  • Principal pays down the amount of the loan.
  • Interest is the interest on your loan.
  • Taxes are your real estate taxes (take the yearly tax amount and divide by 12 and you’ll know your monthly tax responsibility).
  • Insurance is insurance you’ll need to protect the home (the home’s value multiplied by .0025, then divided by 12 is generally a good rule of thumb, but talk to an experienced agent to get a better quote).

If you establish escrow, the prescribed amounts will be set aside each month and paid for you when the bills are submitted.  Then, when your property tax bill comes in, your lender will pay it out of your escrow account.  Likewise, when your insurance bill is due, your lender will pay THAT out of your escrow account, as well.  But if you decided not to establish escrow <cue scary music>, you’d be responsible for paying those bills when they come due, and assuring you had the appropriate amounts in reserve.

For some (including myself), having an escrow account means that I pay a little more of a monthly payment each month, but I know that the appropriate bills are being paid when they come due.  You might be different, however – you might want a lower monthly payment and are willing to set aside the right amount each month to be sure you have enough in reserve when the bills are due.  I just don’t have that kind of self-control.  But remember that just because the payment is lower, that doesn’t mean not having an escrow account means you have a lower monthly payment overall.  It’s six of one, half dozen of another.

3 thoughts on “What Is “Escrow”, And Do I Need It?

  1. JT

    It is probably best that most people escrow their taxes & insurance. However, I don’t have this…for whatever reason it wasn’t set up this way when I last refinanced. I recently online with my city (Alexandria, VA) to go about having my property taxes deducted on a monthly basis vs. twice a year. I ultimately decided, and this barely qualifies as a reason, that I could set this money aside for 6 months earning interest before paying the bill. Interest rates are terrible right now, but it is still something. If budgeting is your problem than just set up an online savings account (SmartyPig.com pays 1.75% APR currently) to withdrawal the amount from your checking account on a monthly basis. Same difference as what the bank is doing on your behalf when you escrow, but the bank keeps the interest 😉 Just think about the millions of borrowers they do this for and how much money they make off just interest payments in exchange for paying some bills…

  2. Anonymous

    Then I’m glad it was helpful. Any other things you were wondering about? Email me and maybe I can work them in!

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