If you own a home, your mortgage loan probably has an escrow account attached that is used to pay home insurance and property taxes when those bills come due. You can maximize the return on the money you set aside throughout the year by ditching your escrow account if you are willing—and have the bandwidth—to be more hands-on regarding these expenses.
Lenders typically set up an escrow account when originating mortgages. Your lender has a vested interest in making sure that your home insurance and property taxes are paid on time. If your home insurance policy lapses, for instance, then you will likely have difficulty rebuilding your home in the event of a catastrophe such as a fire or earthquake. Similarly, if your property taxes go unpaid, your local tax authority can foreclose on your home, leaving the lender as an unsecured creditor. The most sure-fire way (pun intended!) for your lender to ensure these bills are paid is to collect the necessary amounts from you each month as part of your mortgage payment.
Your lender determines the annual escrow contributions by adding the expected property taxes and insurance costs for the coming year. An additional cushion is also necessary to provide a minimum escrow balance at all times as a bulwark against unexpected cost increases. Dividing the total annual contributions by twelve results in the monthly escrow contribution.
For mortgages on a different payment schedule, simply divide the total annual escrow contribution by the number of mortgage payments for the “per-payment” escrow contribution.
As a homeowner myself, I appreciate the convenience of having an escrow account. I make one payment (by autopay, of course) each month to my lender that covers my mortgage principal and interest, and I do not need to worry about paying my property taxes and home insurance. The lender simply takes the funds out of the escrow account when those bills are due.
Property taxes are due twice a year in the District of Columbia. Most jurisdictions collect property taxes annually (once a year) or semi-annually (twice a year). In some places—hi, Nevada friends!—property taxes are due quarterly (four times a year).
If this sounds an awful lot like the approach you might take with savings goals using a high-yield savings account (HYSA), you are not mistaken. An escrow account and HYSA savings goals involve exactly the same behavior: Set aside a certain amount of money periodically, preferably by automatic transfer, and draw down those funds when the expense arises. If you can set aside money all year to take a two-week vacation each summer, you can also set aside the money for your property taxes.
One frustrating aspect of having an escrow account tied to your mortgage, though, is that unlike an HYSA, escrow accounts often pay little or no interest, so you get no financial benefit from setting aside the funds each month. Why not self-escrow in an HYSA so you can earn interest on that money all year? You can! If you feel confident managing the money to self-escrow, take the following steps:
Call your lender and ask if you can cancel your escrow account. Lenders will often allow you to cancel your escrow account once you have made at least two years of on-time payments.
Your lender will then issue you a check for the escrow account balance and inform you of your new mortgage payment amount (i.e., principal and interest only) and your responsibility to make your home insurance and property tax payments—and any other bills paid from your escrow account, like homeowners association dues for some folks—yourself.
Immediately deposit that check into a dedicated “escrow” HYSA.
Set up an automatic transfer into that HYSA for the same day as your mortgage payment. The amount should equal what was formerly the escrow portion of your mortgage payment. Your personal bank account will be debited the same total amount on the same date as before, but now that total amount will be split between your lender and your HYSA escrow account.
Call your insurance company and let them know that you will be making the home insurance payments yourself, rather than through your mortgage lender. Be sure to ask whether there is a discount for self-pay!
Set calendar reminders for yourself about two weeks before the due dates for your home insurance and property tax payments. You do not want to miss these.
At least once a year, calculate your new “escrow” payment and update your automatic transfer accordingly. December is a great time for this!
Watch your HYSA account balance increase faster than your mortgage escrow account balance otherwise would.
The drawback to self-escrow is that you are responsible for being aware of when your home insurance, property taxes, and other escrow expenses come due, and for making sure those expenses actually get paid. But by setting up automatic reminders and transfers, most of that extra work is a one-time effort on the front end.
Self-escrow works exactly the same regardless of the type of real estate: primary residence, vacation property, or rental.
You will also need to be able to forecast your self-escrow amount each year. Property tax rates are usually determined well in advance, so you can get a general idea of how much you will need to pay next year. Insurance companies can also usually tell you what your amount due will be well ahead of time. You can also simply look at your property tax and home insurance history to get a general idea of how much they increase every year, and then add a few percentage points to err on the side of caution.
We ditched our escrow account earlier this year. The escrow portion of our mortgage payment now simply goes to a dedicated HYSA instead of our lender, and I do not devote any mental energy to the home insurance and property taxes because calendar reminders do that for me. In just the first month—which was only a partial month after depositing the check for the escrow balance—we had already earned more interest in that HYSA than we had earned in our escrow account in over two-and-half years since purchasing our home.
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