When you close a mortgage loan, the base payment you're responsible for is made up of principal and interest. But in some cases, you must also pay taxes and insurance along with your base payment (called PITI, which represents principal, interest, taxes and insurance). A common question prospective homeowners ask is whether a borrower is required to include her property taxes along with the principal and interest payment for a mortgage loan. Whether you must pay property taxes with your payment depends on the lender.
When a mortgage lender includes your property taxes in with your monthly principal and interest payment, it's called "escrow." The lender keeps the funds in an escrow account and allows it to accumulate until the tax bill comes due. The lender then submits the payment to each local tax authority on your behalf. Escrow payments also include homeowners insurance premiums.
Escrow is a useful requirement for reasons that benefit both the lender and the borrower. For one, the borrower doesn't have to worry about keeping up with real estate tax bills that come in the mail and submitting them on time. He can just pay one flat fee every month and allow the lender to handle the rest. Lenders like escrow because it ensures that the property tax bill gets paid. It acts as a protection from issues with tax liens (claims) on the house due to nonpayment, which could trump the mortgage lien.
In some cases, the lender may require escrow as a condition of the loan to protect the mortgage company if the borrower doesn't have a very favorable credit history and can't pay a down payment of at least 20 percent (the exact requirements may vary). In other cases, you have an option to either pay the taxes yourself or include it with your loan. Some lenders may extend a small interest rate discount when you choose escrow. Discuss this with your loan officer well in advance of closing your mortgage loan.
In many cases, it's best to simply take the option to pay escrow along with your monthly mortgage payments due to the convenience. But you may have a few personal reasons for wanting to pay the taxes yourself each year. For example, you may like the control of being able to manage that separate bill on your own. If the mortgage company accidentally submits the wrong amount (or no payment at all), you may have to resolve the discrepancy yourself at your county or town's tax office.