How Does Homeowners Insurance and Escrow Work?
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When you buy a house, your mortgage lender takes on a financial interest in your home. Your lender will set up and manage an escrow account on your behalf to ensure certain important recurring expenses get paid on time.
Here’s what you need to know about homeowners insurance and escrow:
What is a homeowners insurance escrow account?
A mortgage escrow account holds money in reserve for home expenses — like homeowners insurance and property tax — that you pay as part of your mortgage payment. The account is established when you close on your home, with funds you pay as part of your closing costs. Your mortgage company or servicer manages the account and pays the bills on your behalf when they’re due.
Having an escrow account helps you budget for these expenses by combining them into a single PITI (principal, interest, taxes, insurance) mortgage payment. It also gives your lender confidence that makes your home loan less risky to your lender by ensuring necessary expenses will get paid.
Homeowners insurance is one home-related bill commonly paid from an escrow account.
Once you start making your monthly mortgage payments, your lender or mortgage servicer will put a predetermined amount of each payment into your insurance escrow. Then, when your homeowners insurance premium is due, the lender will pay it from that escrow account on your behalf.
How does homeowners insurance escrow work?
Mortgage lenders make homeowners insurance a condition of closing on a home sale, so you’ll likely make a premium payment sometime during the closing process.
If you choose to — or are required to — pay a portion of your homeowners insurance as part of your monthly payment rather than separately on your own terms, your lender will set up an escrow account where that money will remain until the premium comes due.
The lender will divide your annual insurance premium by 12 to calculate how much you’ll need to pay into the escrow account each month to cover your premium.
The monthly escrow payment is added to your regular mortgage payment, so you only have one bill to pay each month.
Learn More: How Much Does Homeowners Insurance Cost?
Pros and cons of homeowners insurance escrow
An escrow account provides definite benefits, but it also has some drawbacks.
The primary benefit of an insurance escrow is that it relieves you of having to remember to make your homeowners insurance payment. Some other ways escrow can help include:
- One payment: You have just one payment to make on your home, which makes it easier to budget.
- Simple to manage: Monthly contributions to your escrow account keep the payments manageable compared to lump-sum annual payments.
- Easier to adjust to premium increases: You’ll typically have a couple months’ worth of insurance payments in reserve, giving you time to adjust to price increases.
Be sure to consider the following drawbacks if you need to use an escrow account to pay for your insurance premiums:
- Increases your monthly payment: Breaking down your homeowners insurance premium and property taxes into smaller payments throughout the year makes it easier to manage them, but it also means a higher monthly payment.
- Estimate inaccuracies: Your escrow payments cover the lender’s estimate of your annual insurance premium. Your mortgage payment will increase if the premium goes up or your lender provides an inaccurate estimate.
- Not foolproof: You’ll still have to stay on top of your payment due dates and disbursements from your escrow account to make sure the premium gets paid.
Do I need to have home insurance after I pay off my mortgage?
You’re free to discontinue your homeowners insurance policy once your mortgage loan is paid off. But before you do, it’s important to consider the potential consequences of leaving your home uninsured.
Homeowners insurance covers both the structure and the contents of your home against losses from fire, theft, vandalism, and many other perils. It also pays for accommodations while your home is being repaired or rebuilt if it was damaged by a covered event.
In addition, standard home insurance policies include liability coverage that can pay for medical care in the event someone is injured on your property — and cover your legal expenses if they sue. It even covers damage that you, your family members, or your pets cause to other people or their property.
Then review your coverage to make sure it still suits your needs. Shopping around to check rates from several companies will ensure you get the best coverage at the right price.
Learn More: Is Homeowners Insurance Required?
Homeowners insurance escrow FAQs
Here are answers to some commonly asked questions about homeowners insurance and escrow accounts:
What if the lender doesn’t pay on time?
If the lender pays late or misses a payment, it’s responsible for any penalties imposed by the insurance provider. Contact the lender or servicer to get the issue resolved in a timely manner.
In the event a late or missed payment causes your policy to be canceled, your lender must contact the insurer to get the policy reinstated or purchase a new policy on your behalf, according to the Office of the Comptroller of the Currency.
How do I determine which homeowners insurance to use?
Your mortgage lender will let you know what kind of insurance it requires you to have: actual cash value, which covers the depreciated value of your home and personal belongings, or replacement cost, which covers the full cost of repairs or replacement.
Next, determine how much coverage you need based on the value of your home and property, and then get price quotes from several insurers to compare rates.
What if I want to change my homeowners insurance company?
Once you’ve selected a new insurer and policy, select a date for the new policy to take effect, and verify the time it goes into effect. Then contact your current homeowners insurance carrier to request that your current policy be canceled on or after that date and time.
Remember to contact your lender to let it know about the insurance policy change before it goes into effect. You might need to provide a written statement and your new declarations page to verify your latest coverage.
The Credible marketplace, which includes insurance services by Young Alfred, makes it easy to find a carrier and policy that’s right for you.
Disclaimer: All insurance-related services are offered through Young Alfred.