Owning a home is the American dream. You may have questions about the process that helps you fulfill that dream. When you find the house you want and start shopping for a mortgage, you’ll find most banks require an escrow account, which you fund, and they use, to pay your homeowners insurance. Escrow payments are included in your mortgage payment, so when you make your monthly payment, you are more often than not paying your homeowners insurance premium at the same time.
TL;DR (Too Long; Didn't Read)
Since money for your homeowners insurance is held in your escrow account for payment, your mortgage monthly payment usually includes this cost.
Purpose of Escrow
Making sure the asset, your home, is protected is the primary concern of the mortgage company. Since it’s your primary concern too, there should be no question that you would maintain insurance on your investment. Mortgage companies are leery, though, so the vast majority of home loans include a clause which requires you to escrow your insurance payments.
As a mortgagee, you are obligated to make a monthly payment equal to 1/12 the total amount of the insurance. This amount is placed in an escrow account, and the annual insurance bill is paid from this separate account.
Benefits of Escrow
Escrowing insurance premiums takes the hassle out of paying the premium yourself. Besides, opting out of this basic requirement is probably more hassle that it’s worth, especially if you’re not prepared to post a 20 percent down payment and pay a substantial waiver fee. Your mortgage contract is a multifaceted document that includes much more than escrow. If you eliminate escrow, it could jeopardize the entire deal.
Cons of Escrow
If you have a problem with someone else using your money without compensation and you’re careful about saving for a substantial annual bill, then opting out of escrow may work for you. Getting the mortgage company to go along with your assessment of the escrow practice and your lack of desire to participate is another story altogether.
In some cases, banks will waive the escrow requirement if you make a substantial down payment. Since banks make money on escrow, they will probably charge a fee for the waiver. Waiver fees run as much as 3/8 of a point, with one point equaling 1 percent of the loan amount.
The Bottom Line
Principal plus interest plus escrow equals your mortgage payment, in most cases. If you buy into the homeowners insurance escrow equation, the transaction will move forward without a hitch. The lender makes money with your escrowed funds, and both of you have the peace of mind knowing that the investment is covered in case tragedy strikes.
If you take a stab at avoiding escrow and win, the insurance obligation is still in place, but you’ll have control over the funds. In this case, you’ll earn the interest on your investment instead of the mortgage company earning it for its own coffers.
Cheryl Withrow is a writer in Michigan’s untamed Upper Peninsula. Following a teaching career she served alternately as editor of the "Washington County News" and the "Geneva County Reaper," and as associate editor of "Bay Life" magazine. Withrow holds a Bachelor of Science in business with a major in accountancy from Wright State University and a Bachelor of Arts in English from Ohio University.