When you pay your mortgage, do you know everything that’s included in your mortgage payment? Often, it can be more than just the standard monthly principal and interest. When you own a home, you are also required to pay for your annual property taxes and home insurance. Lenders often require you to deposit money into an escrow account to make sure your taxes and insurance will be paid.
We’ll go over what an escrow account is and when you have to have one. Then we’ll touch on the implications for your property taxes and homeowners insurance.
What’s an Escrow Account?
An escrow account – a sort of savings account – is set up to protect the lender from borrowers who miss payments toward their real estate taxes and insurance premiums. If these are not paid, local tax authorities may place a lien on your property. So if the property is being sold and taxes are owed, it may cause problems until the party who is owed is paid.
Do I Have to Put Taxes and Insurance in Escrow?
It’s possible to avoid escrow and pay your own taxes and insurance under certain circumstances. This will make your monthly mortgage payment lower, but you’ll have to make separate payments for property taxes and homeowners insurance.
If you’re buying a home, an escrow account may not be required with a high enough credit score and a down payment of 5% if you have a conventional loan and a 10% down payment if it’s a VA loan. In New Mexico, a 20% down payment is required no matter the loan type.
If you’re looking to have your escrow account removed after you’ve been making payments for a while, Quicken Loans has a few requirements.
- You need a minimum equity amount of 10% for removal from a VA loan. Conventional loan escrow removal requires 20% equity.
- You need a FICO credit score of 680 or higher on a conventional loan and 720 or greater on VA.
- If your mortgage is backed by Freddie Mac or the VA, the loan must be at least a year old. Fannie Mae loans must be two years old.
- You must be current on your mortgage. This means you must have no 30-day late payments in the last year. Fannie Mae requires no 60-day late payments in the last two years.
- You have to have a positive escrow balance.
FHA and USDA loans always require an escrow account.
You don’t always have to have one, but there are certain advantages to having an escrow account.
Why Should I Have an Escrow Account?
Paying taxes and insurance through escrow can be a great convenience. Mortgages can be complicated enough, and this is one less thing homeowners have to worry about. With an escrow account, your property tax and homeowners insurance payments are split into more manageable monthly chunks paid throughout the year.
Some people find it easier than having to write a large check in the summer and a larger check in the winter for their property taxes, as well as other checks to cover insurance premiums.
Are Escrow Payments Tax Deductible?
Your property taxes are generally tax deductible on your state and federal taxes. If you have any doubts regarding deductibility, please consult a tax professional.
Assuming your property taxes are deductible, they’re still deductible if you’re paying them into an escrow account. You’ll get a 1098 from your lender or servicer at the beginning of each new year, which will help you report the previous year’s deductible tax payments to the IRS as well as state authorities.
Why Do I Receive a Property Tax Bill if I Have an Escrow Account?
If you’re paying your property taxes through your mortgage servicer, you may wonder why you still get a bill (or statement) from your local taxing authority. In most cases, this is just for your awareness. Your servicer generally gets a copy of the bill and will pay it.
There are a few tax offices in Pennsylvania that don’t automatically send your tax bill to Quicken Loans. If this is the case for you, you’ll be notified to send us your tax bill.
Occasionally, you may receive a one-time or short-term supplemental property tax bill. We don’t collect for these. You’ll have to make an individual payment to your taxing authority.
Switching Homeowners Insurance Policies on Escrow
If you switch homeowners insurance policies before your policy expires, you may receive a refund from your former carrier that’s prorated for the portion of the insurance that went unused for the year. While it may be tempting to spend this refund check, if your policy is paid through escrow, don’t.
Quicken Loans pays for your homeowners insurance policy up front and spreads the payments out for you over the course of the year. If you switch insurance providers and don’t send the refund check to us, we’ll end up paying both policies, which will result in a shortage in your escrow account. When that happens, you’ll have to make up the difference the next year. You can avoid this by sending us the fully endorsed refund check. We have a previous blog post on switching homeowners policies.
Things to Keep in Mind
Be aware that even if you have a long-term fixed-rate loan, your mortgage payment can vary. The principal and interest portion of your payment is fixed, but tax assessments may change and insurance premiums may fluctuate. This makes your entire payment vary.
To be able to cover possible shortages in payments, lenders require an extra two months’ worth of payments be kept in the account as a reserve cushion. Tax assessments and premium adjustments can happen any time during a 12-month period, and lenders will have to cover those shortages either using your escrow account or their own money. If they use their own money, they will recover the shortage by requiring an increase in the amount you deposit monthly into escrow.
Also, when building a new home, understand that your escrow payments may spike once construction has been completed because when lenders calculate escrow, the amount is based on the last disbursement. The last disbursement may only reflect the taxes on the land (if there were no previous house on that land). When construction is complete, the land is now worth more because of the existence of the home; therefore, escrow will be higher.
Lastly, keep an eye on your escrow account since it’s always possible for mistakes to occur. It may be a case where the loan is transferring possession from one lender to another and, in the interim, wires are crossed and the tax bill gets paid by both lenders or by neither. As long as you have made your payments, the onus is on the lender to straighten things out. But the best way to tackle this is to keep a close eye on how your money is being managed.
If you’re unsure whether you should escrow, talk to an experienced mortgage banker who can answer all your questions.
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