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What Does It Mean To “Escrow” Taxes And Insurance?

Escrowing taxes and insurance is a risk mitigator for mortgage servicers

As a homeowner, your financial obligations extend beyond your monthly mortgage payment. Periodically, you are also required to pay real estate taxes and homeowner’s insurance premiums.

Each month, you pay your mortgage payment to a company called a “mortgage servicer” (because they “service” your mortgage each month).

In addition to the risk of not getting paid by homeowners, servicers also face two other risks related to homeowners:

  1. That a homeowner’s real estate tax bill will become delinquent and will be sold to a third-party
  2. That a homeowner’s residence will face catastrophic damages during a lapse in insurance coverage

But these risks can be mitigated.

Rather than assume that homeowners will pay on time, mortgage servicers can pay these bills on the homeowner’s behalf when they come due while passing that cost on as a mortgage statement line-item.

This service is commonly called “escrow”.

The escrow payment varies from homeowner to homeowner, of course. It’s the sum of the amounts due annually for real estate taxes and insurance, divided by 12 months in the year.

That yields a monthly amount which is then added to the homeowner’s mortgage statement each month, and added to a bucket of funds held on reserve by the servicer.

For example, a $3,000 tax bill with a $600 insurance policy = $3,600 in costs annually = $300 monthly paid into escrow monthly.

A $1,500 mortgage payment, therefore, would require a $1,800 check to be written to the mortgage servicer each month.

When a mortgage servicer “escrows” on behalf of a homeowner, it knows that taxes and insurance will get paid on time, thereby protecting its own interests. This is one reason why some mortgage lenders offer lower rates and/or fees for borrowers that choose to escrow.

If you’re unsure about whether escrowing is right for you, be sure to ask questions. As with all financial decisions, there are reasons to choose either route.

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