mortgage escrow

Each year about this time I get an escrow analysis from my mortgage company, Chase.

Chase requires me to make monthly payments into an escrow account that will be used to pay property taxes. At the end of the year, Chase pays the taxes from this account directly the tax assessor.

The U.S. government requires certain mortgage loans to have a property tax escrow account. Even without this requirement, mortgage holders want borrowers to escrow their property taxes (and sometimes insurance) to make sure they get paid. Property tax leins can be senior to mortgage liens, so if you don’t pay your property taxes, the mortgage company can take a hit. And if you let your insurance lapse and your home burns down, there goes the collateral.

On a purely financial level, escrow accounts are a bad deal for consumers. Consumers hand cash over to the mortgage company before the property tax bill is due, rather than keeping it in a bank account where it earns interest.

From a psychological point of view, there’s some benefit to paying the money in equal installments throughout the year.

There’s another interesting psychological question around mortgage escrow, and it goes back to the escrow analysis.

At least once a year, the mortgage company figures out if the amount it is requiring for escrow is enough to pay your taxes and insurance, plus a little cushion. If your account has a deficit, the mortgage company will usually give you two options:

1. Make a one-time payment to cover the deficit.
2. Pay the deficit in equal monthly installments over the year.

Here’s the kicker: if you opt to pay it over the year, you aren’t charged interest on the extra escrow amount. If you do the one-time payment, it’s like you’re adding to the interest free loan you’re giving to the bank via the escrow account. Or, consider the mortgage company has given you an interest-free loan for the amount of the miscalculation, and it’s giving you a year to pay it back.

Unless we have negative interest rates, it doesn’t make sense to choose the first option. You should use extra cash to pay down the loan and save on interest instead, or stick it in the bank and earn a bit of interest.

At least, from an accountant’s perspective.

But there can be a big psychological value to lowering your monthly housing payments. In my home state of Texas, we don’t have an income tax. The state collects its money from citizens via sales and property taxes. Property taxes are quite high at about 2.5% of the home’s value. In my case, roughly 40% of my monthly mortgage payment goes to tax escrow.

In the case of Chase, the company provides a calculator if you want to make a partial payment on your escrow deficit. It’s an option between #1 and #2. By making a small additional escrow deposit I was able to lower my mortgage payment in the thousand column. That gives a nice psychological lift each month when the auto draft is made.

Of course, to really lower that monthly payment, there’s always the option of getting rid of escrow. More on that later.