Waiving Escrows: Considerations for Your Mortgage

Homebuyers are often focused on keeping the monthly payment on their new home as low as possible. Naturally, this is first accomplished by making the largest possible down payment – to minimize the amount of the mortgage loan – as well as keeping the interest rate as low as possible. But there’s also a third way, which is to waive escrows on your mortgage.

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What Are Escrows?

Escrows represent a portion of your monthly house payment that is dedicated to the payment of property taxes and insurance. Your house payment is frequently described as “PITI”, which represents the following:

• Principal
• Interest
• Taxes
• Insurance

“Principal” represents the actual amount of your monthly payment that goes into the repayment of the loan. “Interest” is of course the monthly amount of interest that is due on the outstanding loan balance. “Taxes” cover the real estate taxes that are due on the property. “Insurance” represents monthly allocations to pay for homeowners insurance, private mortgage insurance (PMI), and sometimes flood and earthquake insurance.

What the lender does in establishing the escrows is to create a monthly allowance against what are typically annual expenses. The lender will collect approximately 1/12 of each expense as part of each monthly payment.

Also, an upfront escrow will also be collected at closing. Depending on state law and custom, this will include several months property taxes, a paid homeowners insurance policy for one full year, and one to three months of monthly insurance payments.

The upfront escrows represent a prepayment of these expenses, which is why they are typically referred to as prepaid expenses, rather than closing costs. The allocations collected in your monthly house payments will ensure that money will be available to pay the expenses in the upcoming year.

The advantage to you as the homeowner is that you only need to make a single monthly payment that will cover at least three expenses – the actual mortgage payment, the property taxes, and any insurance premiums due.

What is an Escrow Waiver?

Under certain circumstances, a lender will allow you to waive the escrows on your mortgage. This is referred to as an escrow waiver. It means that you agree to make the necessary payments for your real estate taxes and insurance, in exchange for the lender not escrowing those payments in your monthly house payment.

Not all loans permit this type of arrangement. For example, on conventional mortgages, you generally must make at least a 20% down payment on the property for the lender to waive escrows. This also means that the loan will not require PMI since that requirement normally applies when you’re down payment is less than 20%. On FHA mortgages, escrow waiver is not permitted at all.

The Benefit of Doing an Escrow Waiver

The primary benefit of doing an escrow waiver is that your monthly house payment will be lower. For example, let’s say that your monthly payment will be $1,500, of which $1,000 represents principal and interest, and the remaining $500 are escrows for taxes and insurance.

By waiving the escrows, you drop your monthly house payment down to $1,000. This is a way to minimize your fixed monthly payment, to provide more budget flexibility.

There may also be a benefit at closing. If the lender is waiving escrows, there will be no need to collect upfront escrows, which may – but doesn’t always – reduce the amount of cash required to close on the house.

The Downside of Doing an Escrow Waiver

There are several disadvantages in doing an escrow waiver:

• Escrow waiver fee – Most lenders will charge you an extra fee to waive the escrows. It might be something like .25% of the mortgage loan amount paid at closing. So if your mortgage is $200,000, the escrow waiver fee will be $500.
• You will be responsible to pay your taxes and insurance – In waiving the escrow, you’re removing the monthly allowance for these expenses from your basic house payment. But that means that you will be solely responsible for payment, in whatever increments are required – quarterly, semiannually, or annually.
• You will have to budget for these expenses – When escrows are included in your monthly house payment, you don’t have to worry about paying taxes and insurance. But when you waive escrows, you will have to establish your budget to deal with them.

You should also understand that mortgage documents specifically require that pay your property taxes and insurance premiums when due. If not, you could be in violation of the mortgage, and subject to penalties or even default provisions.

Should You Waive Escrows on Your Mortgage?

It’s important to remember that when you waive escrows, you’re not eliminating any expenses, just moving them from one method of payment to another. Within the course of any given year, the amount of money you will pay for your home will be the same whether escrows are included in your mortgage payment, or you pay them separately on your own.

If you are a regular saver, meaning that you routinely live beneath your means, and are able to save money, waiving escrows can make sense. Since you have a history of being able to accumulate extra money, you will be in a position to pay your real estate taxes and your insurance premiums when they are due.

If on the other hand you have more of a paycheck-to-paycheck budgeting system, you will almost certainly be better off having escrows paid through your house payment. This will avoid the need to come up with large amounts of money to pay your property taxes and insurance premiums when they are due.