Are you currently making payments towards a mortgage? If so, do you know what the different parts of that payment are comprised of? Most commonly, there are 4 different parts that make up a standard mortgage payment and those 4 parts are often abbreviated into PITI which stands for Principal, Interest, Taxes, and Insurance.
Principal and interest are standard for most types of loans and allow you to pay off the amount of money you borrowed over time. In the case of most mortgages, the payment amount is amortized over the length of the loan, causing each monthly payment to be the same amount. This means payments early on contain a much higher portion of interest than later payments, but the dollar amount owed each month stays consistent for the entire loan. We’re not worried about this part today though, so let’s look a little closer at the other two, Taxes and Insurance.
Mortgages are unique compared to car loans, student loans, and many other loans because they often bundle a couple other items into the monthly payment. In most cases, this includes property taxes and homeowners insurance. These aren’t tied directly to the loan itself, but are included to help protect the company issuing the loan in most cases. They do this by charging an additional amount above the principle and interest payment each month, setting that money aside in an escrow account, and then making the tax and insurance payments for you when they are due.
At first glance, this seems like a great service, right? Two less bills for you to worry about over the course of a year!
For most people, this probably is a benefit in the form of “forced savings” that prevents them from coming up short when a large tax payment is due, but for someone who is organized and wants to optimize their finances an additional step, there may be some opportunity cost given up by allowing a mortgage company to handle this money for you. By choosing to handle these savings and payments yourself, it may be possible to make money both on interest from the savings AND the form of payment used.
Let’s dive into the math below and see if there is enough benefit to justify the little bit of extra effort each year.
First, Are You Eligible to Remove Escrow From Your Mortgage?
Before we dive too deeply into the benefits or possible downsides of removing escrow, let’s first look at if it’s possible at all. Each mortgage company will have it’s own set of rules for allowing you to remove escrow and handle tax and insurance payments yourself, but my research shows that most share similar requirements. For example, the loan has to be in good standing, be under 80% LTV, and have been established for more than a year.
Every mortgage lender will most likely have a slightly different set of rules, but here is the bullet-point list from our particular lender:
- The terms of the loan must allow for escrow waiver
- 12 months must have passed since the first payment date
- The loan must have been current for 12 months
- The loan to value ratio (the ratio of the value of the property to the unpaid principal balance) must be less than 80%, based on the original appraised value
- There cannot be private mortgage insurance (PMI) on the loan
- The loan cannot have been modified as a result of the Loss Mitigation process
- There cannot have been any lapse in hazard insurance coverage
- The escrow account cannot have been instituted after property taxes became delinquent
- The loan cannot be FHA insured
- All borrowers on the loan must have a minimum credit score of 620
- There cannot be a negative balance in the existing escrow account
To find your own mortgage lender’s rules for removing escrow, I would explore their online portal (if available) or simply give them a call and ask. If you check off all the boxes for eligibility, then it’s time to check if it might make sense to remove it!
Potential Benefits of Removing the Escrow Account
Aside from being more in control of your own money (which may have an emotional benefit), let’s look at three other potential ways you might be able to save money by handling the escrow function of the mortgage yourself.
Potential Benefit #1: Interest Gained on the Average Escrow Account Balance
Most escrow accounts do not pay any kind of interest on the money that is held for you month over month, but this is not always the case! According to an article on Investopedia, the following states are required to pay interest on escrow accounts:
“The states that do require interest payments on escrow accounts are: Alaska, California, Connecticut, Iowa, Maine, Maryland, Massachusetts, Minnesota, New Hampshire, New York, Oregon, Rhode Island, Utah, Vermont and Wisconsin. There are legal exceptions that may preclude a bank from paying interest.”
I won’t attempt to find the exact rules for each individual state, but doing a google search like “STATE required escrow interest rate” should yield the information you need. Pay attention to both the minimum rate and how often the interest must be paid and verify this applies to your own loan as well. Calling your mortgage provider should also yield this information.
Some states are actually required to pay out 2% per year (such as California) on escrow holdings, which might be hard to beat outside of an escrow account! Depending on where you live, losing out on this interest could actually be a negative of removing the escrow account from your mortgage.
Unfortunately for us, we live in the state of Washington and there are no such rules on required interest payments for escrow accounts, so we’re earning 0% on any money that is held in there month to month. To figure out how much opportunity cost we’re giving up, we need to figure out where else we might put the money and what the average balance of our escrow account is over the course of a year.
As for where else we might put the money, I’m going to stick with a standard savings account with 1% interest. At the moment, there are a lot of different banks offering savings accounts at this level or higher. In fact, with a little effort you can potentially earn 4% or more within a completely safe, FDIC insured account, but I’ll stick to a simple savings account that doesn’t require jumping through any hoops.
As for the average balance, there might be a fancy way to calculate this using your monthly escrow payment and amount of taxes/insurance each year, but I simply decided to look back at our last 12 mortgage statements and calculate it by hand (with “by hand” meaning using excel of course). 12 numbers plugged in and a simple average formula yields an average escrow balance of $1,496.12 for us.
For us, we’re giving up 1% of $1,500 each year or about $15. Not a big sum by any means, but you should run your own numbers to see what you might be missing.
To get your own interest opportunity cost of your escrow account, multiply the average escrow balance by the interest rate on the account you would put the money in yourself. If your escrow account happens to be paying an interest rate already, be sure to subtract that out from your savings account rate first!
Potential Benefit #2: Cashback Gained from Making Property Tax Payments Yourself
Well, the interest didn’t prove to be very exciting (at least for our numbers), but this one has the potential to blow it out of the water if you’re good with credit cards and your providers allow credit card payments for little or no fee. For most people, there will be two major payments that your escrow account is currently taking care of: Property Taxes and Home Insurance Premiums.
For property taxes, I imagine every state/city/county handles them differently, so I’ll focus on our own situation in the city of Seattle, or more specifically, King County. Luckily, our county has a fairly robust online presence which means it’s possible to both check how much property taxes are, if they’ve been paid, and even pay them completely online! Depending on where you live, this process may look very different.
By looking up our house on the King County property tax webpage, I can see that the first half of the year’s payment (due in April) has already been made, but the second half of the payment has not (due in October). I can also see that there is an option to make the payment via Credit Card or e-check, each with their own fee.
A fee of 2.35% may seem like a deal-breaker, as most credit cards earn less than that with regular spending, but there are ways to still make the fee worth paying. First, we could simply use our 2.5% cashback on everything credit card to make the payment and walk away with a small 0.15% profit on the transaction. What would be far more interesting (and profitable) is to instead use a new credit card that we are meeting a signup bonus on to earn 10% or more back on the transaction! We did this numerous times across all of our regular spending last year to earn over 14% on average, but let’s take a specific card as an example.
Right now, Becky and I are both working on the minimum spend of our new Bank of America Merrill+ credit cards. For spending $3,000 in the first 3 months, we will earn 50,000 Merrill+ points. Those 50k points can then be redeemed for $500 cash or towards up to $1,000 worth of airline tickets. If we just look at the conservative cash-out option of $500, that’s a simple earning rate of ~17% back on the $3,000 required spend amount. Because that spend can be on anything that accepts a credit card, there’s no reason we can’t use it to pay our property taxes and get the large cashback benefit!
In our case, we could make the $1,815.17 property tax payment with our Merrill+ credit card for a fee of ~$43, and would profit ~$300. That’s a net gain of $257 and only on half of our annual property taxes! To keep the final numbers more conservative, I’ll adjust the % down to an average of 10% and then apply it across the entire annual property tax cost of $3,630 for us this year. That gives us a net gain of $277 each year ($363 profit – $86 fee) for paying our own property taxes instead of relying on an escrow account!
Potential Benefit #3: Cashback Gained from Making Insurance Premium Payments Yourself
This benefit lines up very closely to the one above, but this time for insurance premiums instead of property taxes. Once again, we need to find out a few key items to calculate how much benefit we might gain from paying these ourselves instead of utilizing an escrow account.
This will depend on your home insurance provider, whether or not they accept credit card payments, and how much of a fee there is (if any). In our case, our provider is USAA and they allow all insurance payments to be made via credit card for no fee! An awesome benefit for someone like us who tries to maximize credit card signup bonuses without getting involved in complicated manufactured spending schemes.
This past year, our home insurance premium was $670.03. As there is no fee to pay with a credit card, we can simply take the conservative 10% rate discussed above to get a profit of $67 for paying the premium ourselves instead of using escrow.
Potential Downsides of Removing an Escrow Account
It’s important to consider the potential pitfalls of removing escrow at the same time as the benefits. I would only recommend this potential financial optimization to someone who is extremely organized and hasn’t missed a bill payment in years (if ever). Missing a single payment could offset any of the benefit gained, and then some, by possibly impacting your credit and causing large fees.
Keeping track of your property tax and home insurance bills will require extra work AND requires that you are disciplined with your cash flow. Having escrow tied into your mortgage keeps all three of these payments condensed into a single transaction each month that is easy to automate away from your paycheck. If having this additional cash sitting in your checking or savings account for months might cause you to spend that money, then don’t remove your escrow account!
For someone that is organized with paying bills on time, is comfortable holding on to a large amount of cash without spending it, and is disciplined with credit card spending, removing escrow may allow you to save hundreds each year, but is probably not the right option for most. Be honest with yourself and your habits before considering the change.
How Much We Will Save Annually Going Forward
After running these numbers for our own situation, we signed the paperwork to remove escrow and sent it off almost immediately. Of course, our mortgage lender may take up to 30 business days to respond (that’s forever!), but this isn’t exactly a change that comes with a lot of urgency. For example, the next payment made out of our escrow account won’t be until October. I’m not sure what exactly happens to the money currently in escrow if they approve our request to remove it (they probably send a check?), but I’m looking forward to having one more aspect of our finances more finely tuned.
Let’s review the numbers we calculated above:
- Interest Gained via a 1% Savings Account: $15 (1% on an average escrow balance of $1,500)
- Cashback earned by paying property taxes with a credit card: $277 (conservative 10% back on $3,630 minus an $86 fee)
- Cashback earned by paying home insurance premium with a credit card: $67
- Total Profit Annually by removing escrow: $359
These numbers will of course vary depending on your own situation, so go crunch the data and see if you can find a few hundred dollars per year as well! I was fairly conservative with our calculation, so I would consider $359 to be the baseline for potential savings each year going forward. In fact, with the way the Seattle housing market has been going, it wouldn’t surprise me if our property taxes continued to climb each year as our house gets appraised by the county at higher valuations. Of course I’d rather pay lower property taxes, but might as well make a small kickback by paying them myself with a credit card instead of letting my mortgage lender handle it via escrow.
An Extra Note on Payment Liability
One additional note that I didn’t find a good place to squeeze in above is the issue of liability. Even if your mortgage lender is taking care of property tax payments, the responsibility of those payments still falls on you. If your mortgage lender makes a mistake, you might be on the hook for any late fees or other consequences that happen as a result. Here’s an excerpt from King County’s FAQ section:
“My mortgage company should pay my taxes. What should I do?”
“It is always the responsibility of the taxpayer to ensure that taxes are paid in a timely manner. Visit our Property Tax webpage or call 206-263-2890 to confirm that your taxes are current. Mortgage companies typically make these payments through a processing company, and the processing companies typically submit them to us during the final week that they are due. Contact your mortgage company if your payment is still not showing as paid by ten days past the tax due date.”
I’d prefer to have this kind of liability in my own hands, which might be an additional reason to remove escrow, but that’s for you to decide. Not to mention that if you ever plan on paying off your mortgage completely, you’ll be forced to take on this responsibility of saving for and making these payments in a timely manner each year anyway.
If you decide to crunch your own numbers, be sure to comment below on whether or not you plan to try removing your escrow account.
How much of a benefit would you need to consider taking on the additional responsibility of handling these payments yourself?