Escrow accounts offer a convenience to homeowners as a way to save money throughout the year for insurance and taxes. You may want the freedom to keep your money throughout the year and pay the bills yourself. Unfortunately, if you opted for an Federal Housing Administration loan, you cannot bypass escrow for a do-it-yourself approach. FHA rules require lenders to set up and use an escrow account to pay your insurance and property taxes each year.
Escrow accounts are established for homeowners as a way to pay out important mortgage-related bills such as homeowner's insurance, mortgage insurance and property taxes. Failure to maintain homeowner's insurance on the property places the lender in financial risk if the property is damaged. If the homeowner fails to pay property taxes, your local municipality could place a lien on the property. FHA requires escrow loans to ensure these important bills are paid on time, protecting its investment.
Mortgage insurance pays out to the lender in the event of a foreclosure. You pay out a lump sum at closing for the upfront mortgage insurance premium. You also pay a monthly payment into an escrow account each month. Whether you pay mortgage insurance depends on the loan-to-value ratio used by the FHA. A higher down-payment on the property -- typically around 20 percent -- eliminates the need for mortgage insurance. As you gain equity in the property, FHA cancels mortgage insurance. FHA requires a loan-to-value ratio of 78 percent on a house note greater than 15 years to automatically cancel mortgage insurance.
Homeowner's insurance covers property damage in the event of natural disaster, theft, accident or fire. When you signed the mortgage contract, you agreed to maintain a specific level of coverage on the property at all times. Failure to keep homeowner's insurance is a default of your contract. Your lender divides your annual bill by 12 months. That amount is added into your escrow payment along with your property taxes and mortgage insurance.
Your mortgage lender pays out your insurance premium and property taxes at the designated time in the year. If the lender fails to make the payment, you do not have to pay any assessed fees or interest on the oversight. If you receive a bill from the account holder, forward that bill to your mortgage lender. The lender issues payment to fix the oversight. Your mortgage lender issues an escrow analysis letter each year stating when your debts were paid and anticipating your upcoming costs. Review this letter carefully to ensure your funds are appropriately managed on your behalf. Escrow accounts are managed by your lender but the money still belongs to you.
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