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Escrow is money, property or a written document (such as a bond) delivered or held by a third party pending the fulfillment of an agreement. Banks and lenders use escrow accounts to make sure borrowers have homeowners insurance and the means to pay for it. These accounts are commonly used in mergers and acquisitions, court case settlements and real estate transactions.
A home is a big investment. Most people cannot afford to purchase one in full with cash, so they pay for it in installments using a mortgage with a bank or lender, to whom they make the payments. To protect their interest in the home, banks and lenders require people to have homeowners insurance, and to make sure they do, they use an escrow account.
How homeowners insurance escrow works
Your bank or lender creates the escrow account at the time that you sign your mortgage agreement and manages the account thereafter. This may not happen for all homeowners — it's largely dependent on your bank and your financials. For example, Wells Fargo is one institution that offers this service. It can be a convenient feature to have, since all of your bills are consolidated into a monthly payment.
You pay a lump sum each month to the escrow account and your mortgage lender puts the money toward your mortgage payment and pays your insurance premiums directly to your insurer. The components of this payment (mortgage principal, interest, property taxes and insurance) are often referred to as the acronym "PITI."
The data to determine your total payment usually comes from the tax authority in your state, your homeowners insurance company and the bank itself through the mortgage it provides. This way, the banks and lenders know the premium is paid and that the home is insured. Since rates change, at the end of the year, if you paid too much toward any amount owed, your bank or lender will refund your money.
What if my lender didn’t pay my insurer on time?
Even if you paid your premium on time to your mortgage lender, mistakes can happen. If you get a notice from your insurance company that your premium wasn’t paid, contact your mortgage lender immediately. Section 6 of the Real Estate Settlement Procedures Act (RESPA) requires that mortgage lenders make escrow account disbursements on time. If they fail to do so, a borrower can file a lawsuit against them under Section 6.
If your lender does not resolve a payment issue, you can file a complaint with the U.S. Department of Housing and Urban Development (HUD), the Consumer Protection Office or your State Attorney General's Office. You might want to speak to an attorney about litigation as well.
Will my escrow payment decrease if my home insurance premium goes down?
If you renew your home insurance policy and the cost of your premium goes down, make sure to notify your mortgage lender. Remember, a lower homeowners insurance does not necessarily mean the total payment to your escrow account will be less. Even if your homeowners insurance premium goes down, your mortgage payment or property taxes might independently increase and offset the lower premium.
For example, say you are making a monthly mortgage payment of $2,000 and paying a monthly insurance premium of $200 (a total of $2,200) to an escrow account. If the cost of your monthly premium goes down $25 but your mortgage payment goes up to $50, you would owe $2,225 per month. So even though your premium went down, that does not necessarily mean your escrow payment will.
Should I keep my home insurance after I pay off my mortgage?
Yes, you should absolutely keep your homeowners insurance policy after you’ve paid off your mortgage. Think of it this way, most mortgage lenders require you to have homeowners insurance for a reason — that same reason applies to you: Homeowners insurance protects your home and personal property you’ve invested in over the course of the mortgage.
For example, say you paid off your mortgage and own a $200,000 home outright. If you don’t have homeowners insurance and the home is destroyed by a fire, you can consider that $200,000 gone. If that same $200,000 home was insured, you can use the insurance proceeds towards replacing a roof over your head.
Don’t forget that homeowners insurance also covers more than the home itself and the homeowners personal belongings. Home insurance also includes liability insurance and additional living expenses (ALE). Even if you have paid off your home, both coverages are important to have to protect yourself in a lawsuit and to cover temporary accommodations, respectively.