When you take out a mortgage on a home, the lender will require you to buy a home insurance policy. Depending on several factors, your lender may require you to pay your home insurance premiums through an escrow account. Escrow accounts ensure that insurance premiums are paid on time, but they also enable you to avoid a big annual lump-sum payment.
If you don’t have an escrow account and don’t pay your home insurance premium or property taxes, the lender can take certain actions. The lender may add an escrow account to your mortgage or add the delinquent amounts to your mortgage balance. In certain cases, a lender may also buy a homeowners policy that costs more than the one you purchased, then send you a bill.
- Many homeowners home insurance payments are part of their monthly mortgage payment and are typically kept in an escrow account.
- An escrow account enables you to spread out two large payments over 12 months, and it can help you avoid unexpected insurance or tax increases.
- Paying your homeowners premium and property taxes through an escrow account isn’t required for all home loans but is common.
- If your lender doesn’t require an escrow account, consider requesting one if you want to make monthly payments instead of yearly ones.
What Is Homeowners Insurance?
Homeowners insurance, also called home insurance, covers your home, its contents, and more. You pay an annual premium for the coverage, and the insurance company pays for covered losses up to your policy’s limits. For example, if a fire damages your home, your homeowners policy can help repair it and pay to replace damaged items such as your rugs and furniture. Most standard home insurance includes six coverages:
- Other structures
- Personal property
- Loss of use
- Personal liability
- Medical payments to others
Homeowners insurance isn’t required by law. However, if you take out a mortgage, the lender will require you to buy a policy and maintain coverage until you pay off the loan. Many lenders require you to pay your home insurance through an escrow account.
Homeowners Insurance and Escrow
An escrow account is an account your lender or mortgage servicing company uses to pay critical, recurring, property-related expenses. A mortgage escrow account typically collects and holds funds to pay your homeowners insurance and property taxes.
An escrow account enables you to spread out insurance and tax payments instead of paying them with lump sums every year. By requiring an escrow account, the lender has more assurance that your insurance and tax payments are made on time.
When insurance payments lapse, you run the risk of losing coverage. If you don’t pay your property taxes on time, the government could place a lien on your home.
The mortgage servicer manages the escrow account. Your only obligations are to make regular monthly payments and review your escrow statements to make sure payments are made in full and on time. Homeowners premiums and annual property taxes fluctuate. When changes occur, the mortgage servicing company will adjust the amount you must pay to the escrow account.
Federal law requires mortgage servicers to provide an annual statement of escrow account activity. The statement will include your escrow payments and escrow account balance. It will also include any anticipated increases or decreases in escrow deposits and their effective dates.
How To Set Up an Escrow Account
When an escrow account is required, the lender will set it up for you. If an escrow account isn’t required, the lender will usually give you the option to open one.
Lenders require escrow accounts for numerous reasons. In 2013, the Consumer Financial Protection Bureau issued a rule under the federal Truth in Lending Act that requires lenders to collect escrow payments for at least five years on higher-priced mortgage loans (HPML). HPMLs are loans with an APR that’s a certain number of percentage points above average prime offer rates (APOR), which is an average of mortgage interest rates, fees, and other terms for highly qualified borrowers. HMPLs include:
- First-lien mortgages: With a first-lien mortgage, the lender is the first in line to receive payment following foreclosure. A first-lien mortgage is considered higher-priced if its APR is at least 1.5 percentage points higher than the APOR.
- Jumbo loans: First-lien jumbo loans are higher-priced if their APR is at least 2.5 percentage points higher than the APOR.
- Subordinate-lien mortgages: Sometimes called “junior-lien” mortgages or “second-lien mortgages,” subordinate-lien mortgages are second in line for payment following foreclosure. These types of loans are considered higher priced when their APR is at least 3.5 percentage points higher than the APOR.
A lender may also require an escrow account if you put less than 20% down when you buy your home.
If You Don’t Have an Escrow Account Requirement
Typically, if you make at least a 20% down payment, you can choose whether you want to pay insurance premiums and property taxes through an escrow account. But if you don’t have an escrow account, you’re responsible for paying your home insurance premium and property taxes on time in full.
Mortgage servicers can waive the escrow-account requirement if:
- You ask for it, laws don’t prohibit it, and you’re current on your mortgage
- Your mortgage balance is less than 80% of the home’s original appraised value
- You weren’t late more than 30 days on your payment in the past six months
Homeowners Insurance vs. Private Mortgage Insurance
Your lender may also require you to pay private mortgage insurance (PMI). PMI protects the lender if you stop making your mortgage payments. Collecting insurance and tax payments through an escrow account protects the lender from tax liens and uninsured losses, while PMI protects the lender if you default on your mortgage.
Lenders typically require PMI when you make less than a 20% down payment on a conventional loan or refinance a property that has less than 20% equity. If required, the lender will arrange PMI coverage through an insurance company.
Frequently Asked Questions (FAQs)
How do I know if homeowners insurance is included in my mortgage payment?
When you take out a mortgage, you’ll receive a stack of documents, including one called “Regulation Z”. If the lender requires you to pay home insurance and taxes through an escrow account for a HPML, it will appear in the payment schedule of the Regulation Z document.
When is escrow required for a mortgage?
A lender may require you to have an escrow account if you make less than a 20% down payment on the home. An escrow account may be required if your loan qualifies as a HPML. HPMLs can include loans that exceed conventional loan limits and those with higher-than-average interest rates.
How much homeowners insurance do I need?
You should carry enough dwelling coverage to completely rebuild your home. Most standard home insurance policies include personal property coverage equal to 50% to 70% of your dwelling coverage. If that’s not enough to cover some of your most expensive items, you may need to buy scheduled property coverage. You should also purchase enough personal liability coverage to protect all your assets.