Should I Remove Escrow From My Mortgage? A Deep Dive

The short answer is: it depends. Removing escrow from your mortgage can be a financially savvy move for some, granting greater control over your funds and potentially freeing up cash flow. However, it also comes with significant responsibility and potential pitfalls, making it unsuitable for others. Determining if it’s right for you requires a careful assessment of your financial discipline, risk tolerance, and overall money management skills.

Understanding Escrow Accounts

Before diving into the pros and cons, let’s define what an escrow account is in the context of a mortgage. Essentially, it’s a dedicated account managed by your lender (or mortgage servicer) to pay for your property taxes and homeowner’s insurance. Each month, a portion of your mortgage payment goes into this escrow account. The lender then uses these funds to pay these bills on your behalf, ensuring they’re paid on time and preventing potential liens on your property.

The Allure of Removing Escrow

For many homeowners, the idea of removing escrow is tempting. You gain direct control over your money, potentially earning interest on the funds before paying your taxes and insurance. This can be particularly attractive if you’re a disciplined saver and can reliably set aside funds for these expenses.

The Pros and Cons of Escrow Removal

To make an informed decision, let’s weigh the advantages and disadvantages of removing escrow from your mortgage.

Pros: Greater Financial Control

• Interest Earning Potential: The most significant advantage is the ability to earn interest on your tax and insurance funds before they’re due. While the interest rates might be modest, every little bit helps.
• Flexibility: You have the flexibility to shop around for the best homeowner’s insurance rates and negotiate property tax assessments more proactively.
• Potential for Lower Monthly Payments: While your overall expenses remain the same, removing the escrow portion from your monthly payment reduces the amount you pay to the lender each month. This can free up cash flow for other investments or expenses.
• Investment Opportunities: You can invest the money earmarked for taxes and insurance, potentially earning a higher return than a savings account (though this comes with increased risk).

Cons: Increased Responsibility and Risk

• Discipline is Paramount: This is the biggest hurdle. You must be disciplined in setting aside funds each month to cover your taxes and insurance. Missing payments can lead to penalties, late fees, and even foreclosure.
• Potential for Mishaps: Life happens. Unexpected expenses can tempt you to dip into your tax and insurance savings, leaving you short when the bills come due.
• Foreclosure Risk: Failing to pay property taxes is a serious issue. The taxing authority can place a lien on your property and ultimately foreclose if the debt isn’t satisfied.
• Lender Requirements: Your lender may have specific requirements for removing escrow, such as a minimum loan-to-value ratio or a strong credit history. They may also charge a fee.
• Budgeting Challenges: Estimating your property taxes and insurance premiums can be tricky. Underestimating can lead to a significant shortfall when the bills arrive.
• Higher Interest Rate Potential: Some lenders will increase the interest rate on your mortgage if you remove escrow. They see it as adding risk to the loan.

Assessing Your Financial Readiness

The decision to remove escrow hinges on your financial situation and habits. Ask yourself these questions:

• Are you disciplined with your finances? Can you consistently save money each month without dipping into it for other expenses?
• Do you have a stable income? A reliable income stream is essential to ensure you can consistently fund your tax and insurance savings.
• Do you have a good understanding of your property taxes and insurance premiums? Accurately estimating these costs is crucial for successful escrow removal.
• Are you comfortable with the responsibility of managing these payments? You must be organized and proactive in paying your taxes and insurance on time.
• What are your lender’s requirements for removing escrow? Understanding their criteria and potential fees is essential.
• Can you withstand a financial shock? A sudden job loss or unexpected expense shouldn’t jeopardize your ability to pay your taxes and insurance.

The Lender’s Perspective

Lenders require escrow accounts for a reason: to protect their investment. If property taxes aren’t paid, the taxing authority can place a lien on the property, taking priority over the mortgage. Similarly, if homeowner’s insurance lapses, the property is vulnerable to damage, potentially reducing its value and the lender’s collateral.

By requiring escrow, lenders minimize their risk. Removing escrow shifts that risk to you, the homeowner. This is why they often have strict requirements for allowing escrow removal and may even charge a higher interest rate.

Making the Right Decision

Ultimately, the decision of whether or not to remove escrow is a personal one. Carefully weigh the pros and cons, assess your financial readiness, and consider your lender’s requirements. If you’re disciplined with your finances, have a stable income, and are comfortable with the responsibility, removing escrow can be a financially beneficial move. However, if you’re prone to overspending, have an unstable income, or struggle with budgeting, it’s best to leave the escrow account in place.

Frequently Asked Questions (FAQs) About Removing Escrow

1. What is the loan-to-value (LTV) ratio and how does it affect my ability to remove escrow?

Loan-to-value (LTV) is the ratio of your mortgage balance to the appraised value of your home. A lower LTV indicates you have more equity in your home. Many lenders require a certain LTV (often 80% or lower) before allowing you to remove escrow. This is because a lower LTV represents less risk for the lender.

2. Are there any fees associated with removing escrow?

Yes, some lenders may charge a fee to remove escrow. This fee can vary, so it’s essential to inquire about it upfront. It’s often a flat fee to cover administrative costs associated with changing the loan servicing.

3. Can I reinstate escrow if I remove it and later decide it’s not for me?

Yes, in most cases, you can reinstate escrow if you decide it’s no longer a good fit. However, there may be a fee associated with reinstating the escrow account. Check with your lender for their specific policies.

4. How will removing escrow affect my monthly mortgage payment?

Removing escrow will lower your monthly payment to the lender. However, keep in mind that you’ll still be responsible for paying your property taxes and homeowner’s insurance separately. Your overall expenses won’t change; only the way you pay them will.

5. What happens if I forget to pay my property taxes or homeowner’s insurance after removing escrow?

Failing to pay your property taxes or homeowner’s insurance can have serious consequences. For unpaid property taxes, the taxing authority can place a lien on your property and eventually foreclose. Lapsed homeowner’s insurance leaves your property vulnerable to damage and can violate your mortgage agreement. Your lender may purchase insurance for you (at a much higher rate) and add the cost to your mortgage balance.

6. How can I accurately estimate my property taxes and homeowner’s insurance premiums?

Contact your local taxing authority for information on your property taxes. Your current homeowner’s insurance policy will provide details on your premiums. You can also shop around for quotes from different insurance companies to get an idea of potential costs. It’s always best to overestimate slightly to avoid any surprises.

7. What are the tax implications of earning interest on the funds I save for taxes and insurance?

The interest earned on your savings account is typically taxable as income. You’ll need to report this interest on your tax return.

8. Does removing escrow affect my credit score?

Removing escrow itself doesn’t directly affect your credit score. However, if you fail to pay your property taxes or homeowner’s insurance on time, it can negatively impact your credit score. Delinquent tax payments can appear on your credit report, and a lender-forced insurance policy can indicate financial distress.

9. Is it possible to remove escrow from an FHA or VA loan?

Removing escrow from an FHA or VA loan is generally more difficult than with conventional loans. These loans often have mandatory escrow requirements to protect the lender and ensure the property is properly insured and taxed. However, there may be exceptions in certain circumstances. Contact your lender to explore your options.

10. Should I remove escrow if I’m planning to refinance my mortgage soon?

If you’re planning to refinance your mortgage in the near future, it might not be worth the effort and potential fees to remove escrow. The new loan will likely have its own escrow requirements, and you’ll have to go through the process again.

11. My lender requires me to have flood insurance. Can I remove escrow if I have flood insurance?

The requirements for removing escrow when flood insurance is involved can vary depending on the lender and the loan type. Flood insurance is typically a mandatory escrow item, especially in high-risk flood zones. Check with your lender to determine their specific policies regarding escrow removal with flood insurance.

12. What documentation will my lender require to remove escrow?

Your lender may require documentation to verify your financial stability and ability to manage your property taxes and homeowner’s insurance. This could include:

• Proof of income (pay stubs, tax returns)
• Bank statements
• Current homeowner’s insurance policy
• Property tax statements
• Credit report

The specific requirements will vary depending on the lender.