Escrow Insurance: What Is It and When You Need It

Your mortgage companies may require you to set up an escrow account once the mortgage has been approved. Escrow mortgage insurance accounts are usually set up either before or at closing. 

Homeowners insurance and escrow are often used interchangeably. However, it’s important to understand that an escrow account is not an insurance policy but a financial account used for holding and paying money for property-related expenses like property tax, insurance, and others. This distinction helps ensure that the lender's financial interests in the property are protected, while homeowners insurance directly covers property and liability risks.  

 

Total Mortgage’s editorial team has come up with a comprehensive guide on escrow mortgage insurance. This guide will discuss everything about escrow accounts to help you understand why it could be advantageous to you, especially for financial planning and handling shortages.

Understanding Escrow Mortgage Insurance

There are different types of escrow accounts to help individuals and companies ensure the protection of their assets throughout financial transactions. Some common examples are rental escrow accounts for landlords to keep security deposits or escrow accounts for shares and stock purchases. In the real estate industry, the common types of escrow accounts are - 

• Escrow Mortgage Account: This particular escrow account is established by the lender. This write-up will mostly discuss escrow mortgage accounts. For mortgages with an escrow account, the monthly payments are classified into three categories: principal amount, interest, and escrow. One can pay property taxes, HOA fees, flood insurance, mortgage insurance, and homeowners insurance through escrow funds. 

• Real Estate Escrow or Pre-sale Escrow: This account is usually created to safeguard the interests of buyers and sellers, especially when the purchase does not get through. Sellers can ask for earnest money from the buyer, which is deposited in the escrow account and controlled by a third party. When the deal is closed, this escrowed money is used to make a downpayment on the property. If the deal fails, the money goes back to the buyer or seller, as per the agreement.

Paying Homeowners Insurance Through Escrow

In most cases, lenders will want you to get a homeowners insurance. As per the home policy’s mortgagee clause, your mortgage lender will be notified of all renewals, policy changes, and cancellation notices associated with your property insurance. The lender will use the money from the escrow account to pay the insurance bill annually. 

The annual escrow disclosure statement will be sent to the homeowner. It will reflect payments from the past and future, as well as pending payments, and disclose the potential and actual shortage/surplus in the escrow account.

Mortgage payments include property tax and homeowners insurance. But, in certain cases, the HOA or homeowners association fees may not be a part of mortgage payments. Similarly, flood insurance, mortgage insurance, or the community development district fee may not be part of all homeowner's mortgage payments. 

When choosing your mortgage company, you must inquire about paying homeowners insurance through an escrow account. If it is required, you need to speak to a loan officer or an attorney with real estate experience about it and have the documents reviewed.

Paying a Year of Homeowners Insurance at Closing

You must pay your insurance premium for the first year at closing or before it to build enough equity into the escrow account. This lowers or even eliminates the lender’s risk. Without an escrow account, the mortgage company runs a higher risk of losing the asset if the homeowner does not pay the insurance premium, leading to a policy lapse and the property being damaged or destroyed.

Is Escrowing Money for Homeowners Insurance Required?

It is important to note that many lenders require homeowners insurance payments through escrow due to the regulations of the Consumer Financial Protection Bureau and mortgage companies. 

 

• If you took federally backed loans like FHA, USDA, and conventional loans and made a down payment of less than 20%, you are required to maintain an escrow account. In this case, borrowers are also required to have a PMI or MIP owing to zero to low down payment. 

• While the Department of Veteran Affairs does not ask for escrow accounts for VA loans, your lender may still advise you to have one.

•  Individuals who are eligible for conventional loans and have made a down payment of 20% may not be required to maintain an escrow account. 

Advantages and Disadvantages: Paying Homeowners Insurance Through an Escrow

There are pros and cons of having an escrow account for home insurance with a mortgage. Some homeowners prefer having an escrow account, but their mortgage companies may not include one in their requirements. Such homeowners can maintain a voluntary escrow account. 

For many homeowners, escrow accounts make things easier as paying homeowners insurance or taxes becomes a seamless process. Others may not have a choice, as it would be mandatory for them to maintain an escrow account.

Advantages

• If you have maintained it correctly, the escrow account already has the money to pay homeowner insurance bills.

• Payments are taken care of by the lender. This means less effort on your front.

• In certain states, you can earn interest in the escrow account.

• One of the biggest advantages is that if taxes or insurance increase, you are not required to pay the increased amount all at once.

Disadvantages

• Since homeowners insurance needs to be prepaid, the upfront payment is high with closing costs.

• Since the money is not in your personal account, you miss the chance to make short-term investments.

• The monthly mortgage payments are higher.

• As the payments are made by the lender, most homeowners usually do not get to know the actual cost of their home insurance. 

Keeping Your Home Insurance After The Mortgage Is Paid

Many homeowners face this question after the mortgage is paid. Once the mortgage is over, it is not legally mandatory to maintain a homeowners insurance policy. However, you may choose to continue with the policy as it can help you cover expenses if the property is damaged or destroyed. 

A home is a priceless asset. The homeowner's insurance is a financial protection, safeguarding you from unexpected damages and losses to the property. Another advantage is that the insurance covers your personal possessions too that are inside the home. Additionally, if another person is accidentally injured on your property, the insurance's personal liability coverage helps you pay for any expenses like medical bills. 

Conclusion

Now that you have all the necessary details about the homeowner's insurance and escrow accounts, you can make an informed decision about how to manage these financial responsibilities effectively. 

Get in touch with Total Mortgage for expert guidance and competitive mortgage solutions tailored to your needs.

Frequently Asked Questions

How to find the best home insurance company?

Choosing the best home insurance company is a very subjective topic. That's because every person's requirement varies based on their personal choices, situations, and coverage requirements. For instance, a few homeowners may want better costs, while some may choose customer service even if they pay a premium. Some owners may want a policy that offers additional coverage options. 

Therefore, before starting to look for a home insurance company, you should evaluate your specific needs and priorities. You should then research this topic in detail and get quotes from a couple of insurance companies and their carriers. Next, you need to assess and compare all the quotes based on the criteria that are most crucial for you.

What are the consequences if home insurance premiums are not paid on time?

With an escrow account, the lender makes the home insurance payments. Therefore, there is minimal chance that the payment will be missed in such cases. However, the possibility does exist. Sometimes, the policyholder may discontinue the old insurance provider and go in for a new one. In such cases, the insurance company needs to send a notification to the lender about the changes and where to make the payment.

Similarly, if the homeowner refinances the mortgage, the insurance company must be informed about the change. In such cases, documentation errors can occur, leading to delayed payments. The best thing to do is to keep both the lender and the insurance provider updated about any change or cancellation, etc. so that the chances of error are reduced.

Can I eliminate homeowners insurance from an escrow account?

You can use an escrow waiver to remove your home insurance from the escrow account. This can be done when your loan meets the mortgage company's requirements. In the case of FHA and USDA loans, the escrow account needs to be maintained for life. However, as soon as 20% of the home's equity is paid, you can refinance and apply for a conventional loan. The advantage is that with conventional loans, escrow waivers are allowed, usually if the Loan-to-value ratio is less than 80%. However, there might be more conditions; you must confirm them with your mortgage company.

Does my escrow account handle the payment of my home insurance automatically?

It all depends on the terms and conditions of the mortgage agreement. The best thing to do is to speak to your lender and review the documents to understand how the escrow account works and whether the home insurance payment is automatically deducted from the escrow account. If the home insurance is a part of your mortgage, the lender will use the escrow account funds to pay the insurance premium when notified about due payments. Some lenders may allow homeowners to pay their insurance premiums on their own rather than using an escrow account. It all depends on the mortgage company's policies and terms.