If you’re just starting to learn about mortgages, you may have heard a term called “escrow” and been confused by what it means.
Luckily, we’re here to help. An escrow account is a payment plan that sets aside each month the money that you’ll need at the end of the year for property taxes and home insurance.
An escrow account essentially increases your monthly home payments. So, you may be thinking– why would this be helpful for homeowners?
Here are a couple reasons why:
Draft a better budget
An escrow allows you to better gauge all the expenses in your life from month-to-month.
Without an escrow, you may think that you have more disposable funds than you really do – when in fact, a lot of those funds will end up going into your property taxes and home insurance bill at the end of the year.
It’s better to be brought down by reality in the moment than once every year.
Avoid large sums of money due at once
If you’re like most Americans, you have a set salary or at least a general estimate of how much money you’ll make in a given year.
Property taxes and home insurance coming due in one large sum each year can be a huge jolt to the system – especially for those who spend the majority of their salary on living expenses.
Those large sums can easily wipe out an unsuspecting homeowner’s savings account if they aren’t careful, so here the escrow account really comes in handy.
What’s in it for them?
There are definitely aspects that make escrow valuable for the mortgage company as well.
By taking out money each month for property taxes, the mortgage company essentially eliminates the risk that a customer doesn’t pay his or her taxes each year because they simply don’t have the money to make a large one-time payment.
However, you are restricted from using your escrow funds for anything other than which they are intended – property taxes and home insurance. Some may consider this a drawback since escrow funds are technically the homeowner’s money; however, it’s important to remember that the money has already been earmarked for a specific purpose.
Some things to look out for
There are some scenarios you’ll need to consider when starting off with escrow accounts that could be a shock to the system if you’re not prepared.
Year-to-year jumps (and drops)
Every year, your escrow payment is recalculated so that you can have more money pulled each month the next year if needed to pay for a larger insurance or property tax bill.
In most circumstances, there isn’t a very large change in the monthly escrow payment each year. But if there is a series of natural disasters or other factor that significantly increases your home insurance premium, prepare for your monthly escrow to take a jump accordingly.
The second-year hike
Another common scenario is the second-year leap in monthly escrow payments if you begin your escrow at the start of your mortgage.
Your property taxes normally take a leap the second year you own your home, after your home is reevaluated. This is especially true if you built your home or expanded it after purchase.
Your first year of escrow payments are typically based off the previous owner’s property taxes or the property taxes on the lot upon with you built the house. So, when your property taxes take a hike the second year, your monthly escrow payments could nearly double or more the following year. Yikes!
Just make sure to be prepared for these two scenarios when making long-term budget and savings plans, and you’ll be fine.
Want more advice on escrow and mortgages? Call us at (985) 888-1660 to set up an appointment today! Happy Holidays everyone!