Your mortgage is only one expense involved in owning your own home. You'll also owe annual real estate taxes and payments to insure your home against loss. You can save your money all year in order to make your payments, or your mortgage company can add a sum to your monthly payment and set that money aside in an escrow account. When your taxes and insurance comes due, the mortgage company makes the payments using the money in your escrow account. Escrow accounts have both advantages and disadvantages for homeowners.
Convenience
The biggest advantage for both borrowers and lenders of having an escrow account is the convenience of knowing the money will be available to pay taxes and insurance when the bills come due. Since escrow payments are part of your monthly mortgage payment, you're forced to save money toward taxes and insurance ahead of time. The lender doesn't worry about you failing to make the payments, leaving your house uninsured or in debt to your county. And you don't worry about coming up with a big chunk of money to pay the taxes and insurance when they're due. Since the lender takes care of making the payments, you don't have to do so.
Control
When you have an escrow account, you leave paying taxes and insurance to your lender. You have no control over when the payments are made. In some states, you can prepay real estate taxes in December, in order to deduct the payments from your income tax that year. This allows you to pay real estate taxes in both January and December, thus doubling up on payments every other year, which can net you a bigger tax deduction in those years. This isn't an option in every state, but it definitely isn't an option when the mortgage company is in charge of deciding when to make the payments.
Interest
In most states, the mortgage company keeps any interest they earn on the funds in your escrow account. You lose the opportunity to invest that money and collect the interest. You also don't have that money available every month to spend on other things. An escrow account increases the amount of your monthly payments.
Alternatives
Disciplined homeowners set aside a small amount of money each month toward taxes and insurance, in effect establishing their own escrow account. You may or may not have to pay an extra fee at closing to your mortgage lender in order to waive the escrow account. Most mortgage companies will automatically establish escrow accounts for mortgages unless you notify them in advance that you don't want an escrow account. You're still responsible for maintaining homeowners' insurance on your property and for paying your real estate taxes on time.
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