Your lender might require you to take out an escrow account when closing on a new mortgage loan. Or you might decide to set up such an account on your own. These accounts can make paying annual bills easier. But before working with your lender to set up an escrow account, you need to understand exactly what yearly costs these accounts cover.
When your lender creates an escrow account for you, it collects money throughout the year to pay certain costs associated with owning a home. When these bills come due, your lender pays them on your behalf, taking the money out of your escrow account. You'll provide these dollars by paying slightly more with each mortgage payment than you would have had you not created an escrow account. When you close on a new mortgage loan, you'll have to provide your lender a lump sum -- this sum varies depending on the real estate costs that your escrow account will cover -- so that your lender will have enough money to pay the bills.
What it Covers
Usually, an escrow account covers your property tax bills and your homeowners insurance premiums. How much you need to pay throughout the year to cover these costs varies depending on such factors as where you live -- homeowners insurance and property taxes are higher in some parts of the country -- and how large your home is. As an example, though, if your property taxes cost $6,000 a year and your homeowners insurance $1,200, you'd need to pay $600 each month in escrow -- $500 for your property insurance and $100 for homeowners insurance. That amount would be tacked onto your monthly mortgage bill. If you are starting a new escrow account, lenders will generally require at least two months of reserves, according to Realtor.com. In the example here, you'd need to bring $1,200 to the closing table to provide your lender with its two months' worth of reserves.
Your escrow payments are not guaranteed to remain at the same level during the life of your loan. And because of this, your monthly mortgage payment could also change. That's because both your homeowners insurance and property taxes could go up or down. Maybe your town is building a new school. This will most likely increase the property taxes you need to pay, at least until construction on the project ends. Maybe you've added a second-floor addition to your home. This might cause your home insurance premiums to rise. Your lender will boost your required escrow account payments -- after sending you written notice -- to account for these changes.
The main benefit to setting up an escrow account is convenience. If your lender is paying your property tax and homeowners insurance payments, you don't have to worry about it. This means that you also don't have to worry about accidentally sending your payments in late or missing them. You also don't have to worry about saving the money for your insurance and tax bills. These can be significant bills, and it can be difficult to set aside the money for them if your lender isn't automatically doing it on your behalf.
Don Rafner has been writing professionally since 1992, with work published in "The Washington Post," "Chicago Tribune," "Phoenix Magazine" and several trade magazines. He is also the managing editor of "Midwest Real Estate News." He specializes in writing about mortgage lending, personal finance, business and real-estate topics. He holds a Bachelor of Arts in journalism from the University of Illinois.