Having an escrow account is a convenient (and often required) pay-as-you-go way to prorate certain home ownership costs, such as property tax and homeowner's insurance, by paying a percentage of the annual total on a monthly basis. But there are numerous reasons for removing an escrow account so that homeowners can take care of these costs themselves, whether monthly, quarterly or at year-end. For example, if your income is seasonal, intermittent or commission-based, an escrow account may impose an inordinate financial burden during certain times of the year. And if you're an investor, removing your escrow account frees up monthly income that you'll be able to invest.
If you remove your escrow account and invest the same amount of money that formerly went into that account, you'll not only be able to pay your property tax and homeowner's insurance, but you may also generate interest income.
Escrow Accounts and Payment Obligations
When you have an escrow account, each monthly mortgage payment represents one-twelfth of your annual insurance and property tax obligations. Many lenders require an escrow cushion, usually the equivalent of two months’ worth of payments, in case costs escalate unexpectedly.
Some Loans Require Escrow Accounts
There’s generally no good reason, with some exceptions, that you can’t make these payments yourself and put the money for taxes and insurance aside in an interest-bearing account. Start by contacting your lender and finding out if they will consider escrow removal. However, if you have an FHA loan, escrow accounts are required. While VA loans don’t specifically require escrow accounts, for practical purposes it is unlikely the lender will remove an escrow.
That’s because the VA requires that property taxes and homeowner’s insurance are paid, and an escrow account is the easiest way to ensure this. If you took out a high-priced loan, those that are considered more expensive based on interest rates, points and various terms exceeding Consumer Financial Protection Bureau levels, you cannot have the escrow removed for the initial five years of your mortgage.
Meeting the Equity Threshold
If you don’t have at least 10 percent equity in your home, and some lenders may require 20 percent, it’s doubtful that a lender will agree to removing the escrow. That’s because homeowners with less equity in their houses are more likely to default on a mortgage. Once they have more “skin in the game,” a default represents a large financial loss for the homeowner. If you put a down payment of 20 percent or more on your home, your lender may not have required an escrow account.
Equity is not the only consideration. If your escrow account is currently in the red, your lender may not approve a removal. Once your escrow account is again in positive territory, your lender may consider the request. Lenders may not consider removing escrow until you have held the mortgage for a certain period of time, perhaps a minimum of a year. If you ever made a late payment, that may determine whether the lender will consider removing the account. In some circumstances, a lender might allow the closing of an escrow account on your primary home but not on a vacation or investment property.
Making the Request
Call your lender to find out what is needed to remove the escrow account. Most lenders will require that the request is made in writing. Your tax and insurance payments must be up-to-date, and get confirmation from your town and the insurance company. Include the confirmations with the letter. Keep in mind that your lender will probably impose an escrow closing fee. Once the account is closed, you should expect a check for the amount outstanding.
Reasons to Keep the Escrow Account
While wanting to take care of the insurance and tax payments yourself is understandable, weigh the pros and cons before deciding to remove the escrow account. It will mean more paperwork on your part, as you must keep track of when insurance and tax payments are due rather than relying on your lender to take care of it. Even if the lender agrees to remove your escrow, it may still require you to provide proof of these payments, just adding another level of paperwork on your part.
- Some lenders have a loan-to-value maximum ratio requirement for escrow removal. Many banks will not allow you to remove the escrow account if your loan-to-value ratio exceeds 80 percent. This means your balance can be no more than 80 percent of your home's appraised value.
- Banks might also require that your mortgage be a certain age, at least six months old, for example. The lender might require that you have had no late payments and that the property be a primary residence and not an investment property.
- If your lender does not have any balance requirement for closure and the escrow account was at a negative balance when it was removed, you will receive a bill for the shortfall. Pay the bill timely, within 60 days at most.
- Your lender may have a pre-printed escrow account change request form that can be used in place of a letter.
- Some banks, such as ING Direct, do not attach escrow accounts to mortgages at all, leaving the tax and insurance payments up to you from the get-go.
- If the fee to close your escrow account is greater than the interest you might earn on keeping the money in a separate account, you might choose to leave mortgage escrow in place.
A graduate of New York University, Jane Meggitt's work has appeared in dozens of publications, including PocketSense, Financial Advisor, Sapling, nj.com and The Nest.