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Does Escrow Include Property Taxes? A Homeowner’s Deep Dive

In most cases, yes, escrow accounts do include property taxes. But like any financial instrument, the devil is in the details. Understanding how this works can save you from nasty surprises and ensure smooth homeownership. Let’s unpack the intricate relationship between escrow and property taxes, ensuring you’re well-versed in this crucial aspect of real estate.

Understanding Escrow Accounts

An escrow account is essentially a holding tank, managed by your mortgage lender, designed to cover property-related expenses beyond your principal and interest payments. Think of it as a forced savings account dedicated solely to keeping your property in good standing with the local government and insured against potential disasters.

What Expenses Are Typically Included in Escrow?

The most common expenses included in escrow are:

Property Taxes: These are annual taxes levied by your local government based on your property’s assessed value. They fund vital community services like schools, roads, and emergency services.
Homeowner’s Insurance: This protects your home against damage from fire, storms, theft, and other covered perils. Lenders require it to safeguard their investment.
Private Mortgage Insurance (PMI): If you put down less than 20% of the home’s purchase price, your lender likely requires PMI to protect them in case you default on your loan. Once you reach 20% equity, you can usually have PMI removed.

Why Lenders Require Escrow Accounts

Lenders aren’t just being helpful; they’re protecting their investment. By mandating escrow accounts, they ensure that property taxes and homeowner’s insurance are paid on time. This prevents tax liens (which take priority over the mortgage) and uninsured damage, both of which could jeopardize the lender’s ability to recoup their investment if you default.

Exceptions to the Escrow Rule

While escrow accounts are the norm for most borrowers, there are some exceptions:

Large Down Payments: If you put down 20% or more of the home’s purchase price, your lender may waive the escrow requirement, particularly if you have excellent credit.
Loan Type: Certain loan types, like VA loans (under specific circumstances), may not require escrow accounts.
Good Financial Standing: Even with less than a 20% down payment, some lenders might waive escrow if you demonstrate a strong financial history and creditworthiness.

The Mechanics of Escrow and Property Taxes

Let’s break down how escrow works specifically with property taxes:

Estimating Your Property Tax Bill

Your lender will estimate your annual property tax bill based on the most recent assessment of your property or similar properties in the area. They divide this annual amount by 12 to determine your monthly escrow payment.

Monthly Escrow Contributions

Each month, a portion of your mortgage payment goes into your escrow account. This money accumulates throughout the year to cover your property tax bill when it comes due.

Paying Your Property Taxes

When your property tax bill is due, your lender pays it directly from your escrow account. You don’t have to worry about writing a check or remembering the due date.

Escrow Analysis and Adjustments

Lenders conduct an escrow analysis at least once a year to ensure they’re collecting enough to cover your property taxes and homeowner’s insurance. If your property taxes increase (which they often do), your monthly escrow payment will increase accordingly. Conversely, if your taxes decrease, your payment will be reduced.

Escrow Shortages and Surpluses

Escrow Shortage: If your lender underestimated your property taxes or your taxes increased unexpectedly, you might have an escrow shortage. You’ll typically have the option of paying the shortage in a lump sum or having your monthly payment increased to cover the deficit over the next year.
Escrow Surplus: If your lender overestimated your property taxes, you might have an escrow surplus. In this case, the lender will usually refund the surplus to you.

Potential Benefits and Drawbacks of Escrow

While escrow provides convenience and ensures that property taxes and insurance are paid on time, it also has potential drawbacks:

Benefits:

Budgeting Convenience: Spreading out property tax payments over 12 months makes budgeting easier.
Avoidance of Large Bills: You don’t have to scramble to come up with a large sum of money when your property tax bill is due.
Peace of Mind: Knowing that your taxes and insurance are being handled automatically provides peace of mind.

Drawbacks:

Loss of Control: You don’t have direct control over when and how your property taxes are paid.
Opportunity Cost: The money in your escrow account doesn’t earn interest for you.
Potential for Errors: Although rare, lenders can make errors in calculating escrow payments, leading to shortages or surpluses.

FAQs About Escrow and Property Taxes

Here are some frequently asked questions to further clarify the relationship between escrow and property taxes:

Can I choose to pay my property taxes directly instead of using an escrow account? Generally, no, unless you meet specific criteria like a large down payment or excellent credit, as determined by your lender.
What happens if my lender doesn’t pay my property taxes on time from my escrow account? The lender is responsible for paying your taxes on time. If they fail to do so, they may be liable for penalties and interest.
How do I know if my lender is paying my property taxes on time? You should receive a copy of your property tax bill and a statement from your lender confirming that the payment has been made.
Can I remove my escrow account later on, even if I didn’t initially qualify? Possibly. Once you have significant equity in your home (typically 20% or more) and a good payment history, you can request that your lender remove the escrow requirement.
What if I disagree with my property tax assessment? You have the right to appeal your property tax assessment. Your local government typically has procedures in place for appealing assessments.
Does my mortgage interest rate affect my escrow payments? No, your mortgage interest rate and escrow payments are independent of each other.
Are there any fees associated with having an escrow account? Lenders typically do not charge separate fees for managing your escrow account. The cost is factored into the overall cost of the loan.
What happens to my escrow account if I refinance my mortgage? When you refinance, your existing escrow account is usually closed, and any remaining funds are refunded to you. A new escrow account may be established with the new loan.
Can I change my homeowner’s insurance company while having an escrow account? Yes, you can choose your homeowner’s insurance company. Just inform your lender of the change so they can update their records and ensure your insurance premiums are paid from your escrow account.
How is the escrow account handled if I sell my home? When you sell your home, your escrow account is closed, and any remaining funds are refunded to you.
My property taxes just increased significantly! What can I do? Contact your local tax assessor’s office to understand why your taxes increased and explore your options for appealing the assessment. You should also budget for the increased escrow payment.
Is it possible for my lender to miscalculate my escrow payments? While it’s not common, lenders can make errors. Carefully review your escrow analysis statements and contact your lender if you suspect a mistake.

Understanding the intricacies of escrow accounts, especially their relationship with property taxes, empowers you to be a more informed and proactive homeowner. Don’t hesitate to contact your lender or a qualified financial advisor if you have any questions or concerns. Staying informed is the best way to protect your financial interests and ensure a smooth homeownership journey.