Tax and Insurance Escrows

You must have tax and insurance escrows when you have a mortgage lender. However, the real estate tax escrow does not impact the tax value of your home.

Real estate tax and insurance escrows can lead to consumer confusion. Here is a question from a reader on the relationship between tax escrows and the value of a home.

Q: I have a question about what happens to your real estate taxes when you pay off your mortgage. When you have a mortgage, the payment to the lender includes real estate taxes and insurance. Once you pay off your loan, how do taxes get paid? Is it better to pay off your loan or keep a loan so that the taxes keep getting paid? Do property taxes rise when you pay off your loan?

How tax and insurance escrows work

A: You’ve asked some important questions, although we think you might be a bit confused about how your real estate tax and mortgage escrow accounts work.

Let’s start with a basic fact. Whether you carry a mortgage on your property has no impact on what you pay in real estate taxes. Your real estate taxes should be based on the actual value of the home or what your local taxing authority believes your home is worth.

Let’s say you purchased your home for $300,000. The taxing authority might base your real estate taxes on your purchase price or may have some other formula for determining the value of your home. Once it has determined that value, the taxing authority sets the amount of taxes you must pay based on a complicated formula. For our example, the local taxing body might say that your taxes are $3,000 per year. This amount is what you are legally obligated to pay; regardless of whether you are currently paying off a mortgage or not.

Why lenders require tax and insurance escrows

For most homeowners with a mortgage, the lender requires the homeowner to pay monthly into escrow. This amount is a sum equal to what you’d expect to pay in real estate taxes plus a cushion. The same goes for your homeowner insurance premium. If your real estate property tax bill is $3,000 per year, the lender will set the monthly amount you pay into the escrow account at $250. If your homeowners insurance policy is $1,200 per year, the lender will want you to pay an additional $100 per month to cover future insurance premiums. In addition, the lender may require you to put in a cushion typically equal to 2 months’. This cushion should cover increases in your insurance premiums and real estate taxes.

How lenders determine the amounts in escrow

Whatever the sums are, your lender adds them to your monthly mortgage payment. When the lender’s servicer receives your payments, the lender separates an amount due for real estate taxes and insurance. The lender uses those funds to pay those bills when they come due. The primary reason your lender holds these funds is to make sure these two bills are paid on time. The lender does not want a lapse on the insurance policy and doesn’t want the home sold for unpaid taxes.

Having said that, when you pay off your mortgage your lender no longer has the obligation to pay your real estate taxes and homeowners insurance premium. From the day you pay off your loan, you must take on the obligation to pay these bills yourself – on time and in full.

If it’s too much to write those checks once or twice a year, when they come due, you can set up your own escrow account, and deposit 1/12 of the amount due each month into the account. Since you’ll pay off your mortgage, it will hopefully be easier to come up with the funds. You’ll need to remember to pay the bills when they come due. (Check with your tax office to make sure your home address is on the tax bill. You want to make sure you get these bills.)

Tax escrows go up while loan balances go down

The way real estate usually works, as you pay down your mortgage, your real estate tax bill will continue to rise. Recently, we found a tax bill from around 25 years ago. That bill was about one-fifth of our current tax bill. Hopefully, your income over the decades will continue to increase so that paying a heftier tax bill won’t be too much of a burden.

For other real estate terms.

©2021 by Ilyce Glink and Samuel J. Tamkin.