Escrow and Home Insurance: How Your Mortgage Account Manages Insurance Payments

For many homeowners, the monthly mortgage payment can be confusing, with multiple components like principal, interest, taxes and home insurancebundled together. A key part of the mortgage payment for some is the escrow account, which collects funds on behalf of the lender to pay expenses like property taxes and insurance premiums when they are due. But does the escrow account also pay your home insurance? 

Yes, escrow does pay for home insurance. When a homeowner takes out a mortgage, the lender often requires an escrow account to be set up. Each month, a portion of the mortgage payment goes into this account and is used by the lender to pay for property expenses like home insurance premiums and taxes when they are due.

Understanding how escrow works with your home insurance coverage can help you manage this important part of your overall homeownership costs.

How Does Escrow Work with Home Insurance?

When you take out a mortgage, the lender will often require you to set up an escrow or impound account. Each month when you make your mortgage payment, a portion of funds go into the escrow account. The lender holds these funds in trust to pay expenses on the property like insurance and taxes when they come due.

For home insurance, the escrow account pays your full annual premiumdirectly to the insurance company when the policy needs to be renewed. This avoids you having to pay the lump sum yearly premium yourself out of pocket. The lender does this automatically by withdrawing the needed funds from the escrow account.

Benefits of Using Escrow for Home Insurance Payments

Paying your homeowners insurance through an escrow account offers several key benefits:

• Convenience – The lender pays your full insurance premium for you out of the escrow account, saving you hassle.
• Avoid Lapsed Coverage – The lender ensures your policy stays current, preventing any lapse in insurance coverage.
• Budgeting – Your monthly mortgage payment includes 1/12th your full yearly insurance premium, making budgeting easier.
• Interest Savings – Not having to pay the full premium out of pocket saves interest you’d pay on a loan.

Using an escrow account provides a seamless way to pay this major homeownership expense.

Drawbacks of Using Escrow for Home Insurance Payments

However, there are some potential drawbacks to consider with escrow accounts:

• Higher Monthly Payments – Your mortgage payment will be higher with escrow than paying insurance separately.
• Limited Control – You rely on the lender to manage the payments to your insurance company. 
• Overages or Shortages – Fluctuations in taxes and insurance costs can lead to surpluses or shortfalls in the account.
• Difficulty Switching Insurance – Changing insurers may take more time and coordination through escrow.

While escrow simplifies payments, it does mean giving up some control over the process.

How to Set Up an Escrow Account for Home Insurance

If your lender requires an escrow account, it will be set up automatically as part of your mortgage origination process. The lender estimates your annual home insurance premium and property taxes and divides by 12 to calculate your monthly escrow payment amount. 

At closing, you’ll deposit funds covering 2-6 months of escrow payments upfront. Each month, your portion of the mortgage payment allocated to escrow will be deposited to pay upcoming bills. 

You can ask your lender for details on the escrow analysis to see the anticipated disbursements and monthly payment calculations. Monitoring your escrow account statements is wise to check for any overages or shortfalls.

What Happens If You Change Your Home Insurance Provider?

If you opt to change home insurance companies while paying premiums through escrow, you’ll need to coordinate carefully with both the new insurer and lender:

• Inform your current insurance company you are cancelling coverage on a certain date. There may be a cancellation fee.
• Choose a new insurer and arrange for coverage to begin on that same date so there is no gap in coverage.
• Provide your lender details on the new policy and premium amount so they adjust payments from the escrow account. 

Changing insurers mid-year can be tricky with escrow, as you don’t want any lapse in your property being insured. Work closely with your lender throughout the process.

What Happens If You Overpay or Underpay Your Escrow Account?

It’s common for escrow accounts to have surpluses or shortages over time. As insurance and tax bills fluctuate annually, a cushion is built into escrow to cover changes. But significant overages or underages can occur.

If you overpay, the excess funds are eventually returned to you per federal law. For shortages, the lender may spread repayment over 12 months or allow you to pay lump sum. An annual escrow analysis will calculate any adjustments needed to keep the account balanced.

Staying on top of your escrow account statements will allow you to spot any issues early on and address them with your lender before they become major problems.

Can You Stop Using Escrow for Home Insurance Payments?

You may be able to cancel your escrow account and take over direct payment of insurance and taxes yourself. This usually requires paying off a certain amount of mortgage principal first.

For FHA and other government-backed loans, you must have at least 22% equity in the property to cancel escrow. Conventional loans often require 20% equity before allowing escrow to be cancelled.

If you have the equity and want more control, discuss escrow cancellation with your lender. But remember you take on the duty of making timely insurance and tax payments yourself.

What Are the Alternatives to Using an Escrow Account for Home Insurance?

If permitted by your lender, alternatives to paying home insurance via escrow include:

• Paying annually – You pay the full premium directly to the insurer yourself once a year.
• Paying in installments – Some insurers allow semi-annual or quarterly installments, easing budgeting. 
• Paying monthly – A few insurers offer monthly payment plans with no down payment.
• Using bill pay – You can use your bank’s bill pay to send payments on a schedule you preset.
• Paying automatically – Set up autopay directly through your insurance company to have premiumswithdrawn.

These options allow you to have more control over payments but do require monitoring dates and ensuring funds are available.

When Is It Required to Use an Escrow Account for Home Insurance?

There are certain mortgage types and situations where an escrow account for taxes and insurance is required:

• FHA loans – All Federal Housing Administration insured loans require escrow accounts. 
• VA loans – Veterans Affairs mortgages mandate escrow for insurance/taxes.
• USDA loans – US Department of Agriculture rural home loans need escrow accounts.
• Conventional loans with < 20% down – If less than 20% downpayment, lenders usually require escrow. 
• Jumbo loans with < 20% down – Same escrow requirement for jumbo mortgages.

So for most mortgages, especially with low down payments, you’ll be obligated to pay insurance via an escrow account.

Conclusion

In most cases, your lender will handle paying your home insurance premiums through an escrow account set up along with your mortgage. This brings conveniences like avoiding lapses in coverage and easier budgeting. But escrow does entail some loss of control over the process. Understanding how escrow accounts work for home insurance is key to navigating this part of homeownership. Carefully monitoring your escrow statements, tax bills and insurance invoices will ensure there are no payment surprises or shortfalls.

Frequently Asked Questions(FAQ)