The fiscal responsibility of a homeowner extends beyond the mortgage’s basic principal and interest repayments. Homeowners are also responsible for the real estate taxes on the home and its insurance premiums, too.
Failure to pay taxes can lead to foreclosure, and failure to insure is breach of your mortgage contract.
As a homeowner, you have a choice about how you manage your real estate tax and insurance bills. You can choose to pay them from your own bank account when the bills come due, or you can choose to pay 1/12 of the annual bill to your mortgage servicer each month, and then let your servicer pay the bills on your behalf when they come due.
Not surprisingly, servicers prefer the latter method — it reduces two major lender risks:
- That the home’s real estate taxes go delinquent and are sold to a third-party
- That the home endures catastrophic damage during a lapse of insurance coverage
In theory, when the servicer is paying the bills, the home’s taxes are always current and the home’s insurance is always paid. This method of managing taxes and insurance is commonly called “escrowing”.
To calculate a home’s monthly escrow payment is simple. Just take the sum of the annual real estate tax bills and insurance bill, then divide it by 12 months in the year.
As a example, a $4,000 annual tax bill with a $800 insurance policy = $4,800 annually = $400 paid into escrow monthly. These monies are collected as part of the regular mortgage payment along with the mortgage’s scheduled principal + interest payment.Homeowners choosing to escrow tend to get the lowest rate, lowest fee loans. This is because lenders often charge a premium to “waive escrow” (i.e. pay their own taxes and insurance). Escrow waiver fees vary between banks, but can range up to half-percent of the amount borrowed. The larger the loan, the stiffer the penalty in dollar terms.
Choosing to waive escrow can also raise your mortgage rate by up to 0.250 percent.
If you’re unsure whether escrowing is right for you, talk to me and/or financial planner. There’s good reason to go either route depending on your profile.