UPDATED: AUGUST 08, 2023 | 3 MIN READ
Homeowners insurance becomes particularly significant during the escrow process of buying a home. It’s typically a prerequisite for mortgage lenders, safeguarding their financial investment in the property, and the money to pay for it is set aside in an escrow account you set up when you buy your home. Learn more about homeowners insurance in escrow, including its role and the process you need to take to ensure your home and your mortgage requirements are covered.
What is a homeowners insurance escrow account?
A homeowners insurance escrow account is a separate bank account set up by a mortgage lender to pay for several key items related to your mortgage, including your home insurance policy. This temporary legal arrangement allows your lender to hold your property taxes and insurance payments.
Many lenders require you to pay your homeowners insurance through escrow to ensure the bill gets paid on time. However, whether or not you’re required to escrow the money for your homeowners insurance may depend on the type of mortgage you have or the down payment you made.
How homeowners insurance works with escrow
When you pay your homeowners insurance through your escrow account, the process is slightly different than if you were to pay the bill on your own because the payment is routed through a third party. That’s why it’s important to understand the process completely before you continue the home-buying process.
How much money do you need to set aside for escrow?
The amount of money you need to set aside for escrow depends on several factors, including your home’s location, loan amount, property taxes, homeowners insurance premium, and the terms of your mortgage agreement.
Typically, your escrow account holds funds to cover your annual property taxes and homeowners insurance premiums. The standard rule of thumb is to deposit approximately two months’ worth of property tax and homeowners insurance expenses into your escrow account at closing.
For example, if your annual property taxes are $3,600, and your homeowners insurance is $1,200 per year, you would need $800 ($300 for property taxes and $100 for homeowners insurance) for each month. Multiply this by two, and you would need to set aside $1,600 in your escrow account.
However, keep in mind that this is just an estimate. The exact amount may be more or less depending on specific requirements from your lender or local tax laws. Always consult with your lender or a real estate professional to get the most accurate information for your situation.
When does the lender collect your escrow payment?
Lenders typically collect your escrow payments as part of your monthly mortgage payment. Your total monthly payment includes the principal loan amount, interest, property taxes (held in escrow), and homeowners insurance (also held in escrow).
Here’s how it works: when you close on your home and set up your mortgage payment, your lender calculates an estimate of your annual property taxes and homeowners insurance premiums. These estimates are then divided by 12 to get a monthly amount.
When you pay your monthly mortgage payment, the portion for property taxes and homeowners insurance goes into the escrow account. Then, when your property taxes and homeowners insurance bills are due, your lender uses the funds in the escrow account to pay these bills.
This process simplifies budgeting for these large expenses by breaking them down into manageable monthly payments. And it gives your lender assurance that these important bills will be paid on time.
Who is responsible for getting homeowners insurance during escrow?
Even if you’re paying your homeowners insurance through your escrow account, you’re responsible for setting up the coverage – and you can change your coverage whenever you choose.
When you set up the home insurance policy, your mortgage company’s name and contact information are added to the policy. There are two reasons for this.
- If you have a total loss, your mortgage company gets paid first. This way, you don’t have a large amount of debt hanging over your head.
- The insurance company knows who makes the payment, and if needed, has the information to directly debit the escrow account.
Pros and cons of paying your homeowners insurance through your escrow account
Escrow accounts ensure your payments are made on time and that your property is protected by insurance. While an escrow account can be beneficial, it also comes with several drawbacks. That’s why it’s essential to consider whether a homeowners insurance escrow account is right for you.
Benefits of paying for insurance in escrow
Paying for homeowners insurance through an escrow account comes with several benefits:
- Simplified budgeting: Escrow payments break down large annual or semi-annual homeowners insurance bills into manageable monthly payments, which makes budgeting easier by spreading the cost over the year.
- Guaranteed timely payments: When your insurance premiums are paid through escrow, your lender ensures the payment is made on time. This eliminates the risk of missed payments or lapses in coverage.
- Convenience: With an escrow account, your property taxes, mortgage payments, and homeowners insurance premiums can all be paid at the same time. This means fewer payments for you to manage and keep track of.
- Lender requirements: Many lenders require an escrow account for homeowners insurance and property taxes as a mortgage condition. The requirement protects the lender’s interest in the property and ensures that the borrower maintains continuous insurance coverage.
- Potential savings: Some lenders offer a lower interest rate or other incentives if you set up an escrow account, as it reduces their risk. Also, some insurance companies offer discounts for paying your policy in full annually, which you’ll qualify for since the lender would pay the premium once a year.
Disadvantages of paying for insurance in escrow
While there are advantages to paying for homeowners insurance through an escrow account, there are also a few potential disadvantages to consider:
- Limited control: When you pay for homeowners insurance through an escrow account, your lender oversees the disbursement of funds. Therefore, you have less control over the payment timing and process.
- Potential for overpayment or shortfalls: Escrow payments are based on estimated annual expenses. If your homeowners insurance premium or property taxes increase, causing an escrow shortfall, you get a bill for the difference. Conversely, you could be overpaying into your escrow account if these costs decrease.
- No interest earned: Money in an escrow account usually doesn’t earn interest. If you were to manage these funds independently, you could place them in an interest-bearing account.
- Managing changes can be more complex: Changing your homeowners insurance provider requires you to inform your lender to adjust the escrow payments. This adds an extra step to the process.
- Reliance on lenders to make payments: While lenders are typically reliable in making timely payments, errors can occur. If your lender fails to pay your insurance premium on time, your policy could lapse, leaving your home unprotected.
Is it better to have homeowners insurance through escrow?
In most cases, having homeowners insurance inc escrow is the best option because it allows you to spread your payments out throughout the year. In fact, many with many lenders, it’s a requirement – they don’t give you the option to get and maintain insurance on your own.
Does it make sense to escrow taxes and insurance?
For most people, having taxes and homeowners insurance in escrow makes sense. When paid from an escrow account, you don’t have to worry about lapses in coverage or delinquent taxes. Also, it spreads the payments out so you aren’t trying to pay an entire year’s worth of insurance at once.
What happens if escrow is too high?
If your escrow payments are too high, it creates a surplus in the account. You’ll get a refund if you’ve paid too much for the year.
What happens if you don’t put enough money in your escrow account?
If you don’t have enough money in your escrow account to pay your home insurance and taxes, you get a bill for the difference. Your lender might also adjust your next year’s mortgage payments to reflect the increase in costs.
What month do you get an escrow refund?
There isn’t a specific month for lenders to send escrow refunds. Lenders complete an escrow analysis on an annual basis. If you have an overpayment at the time, they’ll send you a refund. Check with your lender to find out when yours is completed.
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