Reader Question: What is Escrow, Should I Pay Extra?

by Kevin on April 16, 2008

Mill Street by Paul KeleherI received a comment recently on the article where I asked How Much House Do You Buy Each Month? Nuggie asked,

How does escrow fit in, and does it ever make sense to prepay escrow?

Here’s a brief overview of escrow in relation to a home mortgage. (You can also get the general idea from Lending Tree’s information on escrow. The following is just my opinion.)

A quick explanation of escrow

Escrow is an account that the mortgage company opens up for you to hold onto different monies. Your homeowners insurance and property taxes are the most common uses for escrow. Part of your monthly payment includes your escrow monies. That means the mortgage company is holding onto your money to insure that you pay your property taxes and homeowners insurance. In fact, they pay them for you.

Why does the bank hold onto escrow for me?

The bank has a vested interest in the house. They require you to have insurance so that if it burns down, you can pay back the money they lent you. They require you to pay your property taxes so that your state/local government can’t take the house from you. That makes sense from a business perspective. I’m not going to lend a few hundred thousand dollars out to someone if I can’t be reasonably sure I will either get the money back or get the asset into my ownership.

Should I ever prepay escrow?

There are not many situations I can dream up where you would want to prepay your escrow. I do know that our mortgage holder, Suntrust Mortgage, gives us the option to apply any additional payment to escrow. As we discussed, escrow payments are based off of your insurance and property tax costs. This should stay fairly consistent year to year. However, a new tax assessment or perhaps upping the coverage on your house could increase either of the underlying costs behind escrow payments.

Your bank may also only make adjustments once per year. Our taxes should be lower than what we are paying into escrow because we were able to homestead our home here in Alabama. But Suntrust told us they only adjust the escrow payment for taxes once per year. If you were going the opposite direction — higher costs — then you might want to start paying extra each month so you don’t end up owing a large amount to your escrow account at the end of the year.

(Photo: Mill Street by Paul Keleher)

Have a question? Don’t be afraid to ask! I love to help clear up concepts or issues for readers. Or feel free to bash me. Whatever feels right. Drop me a line, or leave a comment on a post.

{ 3 comments… read them below or add one }

D.H. September 15, 2010 at 9:31 pm

You mentioned in your post that, “There are not many situations I can dream up where you would want to prepay your escrow.”. Which brings me to my question.. and reason for looking up this information. I am looking into any way that I can reduce my monthly obligations. I was looking into paying off my escrow balance for the year in hopes that it would lower my monthly payments to the mortgage company. Is this the case? Will escrow still be deducted even with a positive balance? I know this does not help me in the long run, however, at this time I am more focused on the now.

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Shannon July 18, 2012 at 10:03 am

I should have put my answer here instead of posting seperately – just in case you were still wondering about your escrow question two years later – check out my post just below. :-)

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Shannon July 18, 2012 at 10:02 am

@D.H. – I know this is two years later, but I recently spoke with a customer service rep at my bank and she told me if I paid more into my escrow account up front each year than my monthly mortgage payments would be less until those escrow funds were spent, then it would adjust again. I.e. if you pay $1800 / month with $350 going towards principle, $850 going towards interest / and $600 going towards escrow, and you toss $7200 into your escrow, then that $600 is lopped off your monthly payments until the escrow funds dwindle. That’s at least how I understood what she told me.

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