Generally, home mortgage payments consist of 4 parts:
- principal (a partial payment toward the amount that was initially borrowed)
- interest (the cost of “renting” the remaining loan balance)
- property taxes
When someone borrows money to buy a house, the lender has a good reason to want to make sure that the property is insured and the taxes are paid. (If the house were destroyed in a fire or other accident, the lender would have no way to collect the debt if the borrower walked away. If the taxes aren’t paid, the local government could seize the house and sell it to pay the unpaid taxes.) Because lenders prefer to make sure that insurance and tax bills are paid, and paid on time, they include those costs in the monthly payments and pass the money along to the insurance company and local government as needed. The money is kept in a separate “escrow” account in the mean time. Federal Housing Administration (FHA) loans always come with an escrow account and include insurance and taxes in the payments.
Many homeowners like escrow accounts just fine. It’s convenient. Not making insurance and tax payments means two fewer things to worry about. Someone lacking in financial discipline might not be able to put enough money aside for the tax and insurance payments, and that could lead to trouble. Simply forgetting to make the payments can lead to late fees, or worse.
However, someone who is able to manage their money and wants to spend a little extra time doing so might want to consider a no-escrow loan. While this does not reduce your taxes and insurance costs, it does let you keep your money in your own account until you need to make the payments. This might allow you to earn some interest from the bank (or credit union!) where you keep your checking and savings accounts. Additionally, you might more easily meet some minimum balance requirement that eliminates monthly service charges.
It’s usually easier to avoid escrow on a new loan and harder or impossible to remove an escrow requirement from an existing loan. Even if you can avoid escrow, watch out: banks might charge a higher interest rate on a no-escrow loan. As always, shop around and negotiate.