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How does homeowners insurance escrow work?

Fact-checked with HomeInsurance.com

Using an escrow account for your homeowners insurance payments provides a layer of protection to both you and your lender. It offers several benefits, especially ensuring your insurance premium is paid on time and in full each year, so that your coverage doesn’t lapse.

Escrow accounts are important to understand when you first buy your house because it costs money upfront to fund the account. But even after you’ve moved into your new home, knowing how escrow works is helpful as you manage and potentially change your homeowners insurance policy.

What is homeowners insurance escrow?

If you’ve ever wondered, “what is insurance escrow,” it’s simply an account managed by a third party. When buying a house, an escrow home insurance account will be opened, incurring a number of fees that aren’t owed to your lender, but that need to be paid in order to keep up with your house. This includes payments that will eventually go towards your property taxes, your homeowners association dues (if you have one) and your homeowners insurance premium.

You’ll likely have an escrow account to help you manage these payments the entire time you have a mortgage. It’s in the lender’s best interest to make sure you stay current on your homeowners insurance so you can get reimbursed in the event of a damaging loss.

How does homeowners insurance escrow work?

Your mortgage lender typically opens an escrow account on your behalf. Rather than making lump contributions directly into that account to be put towards bills like your homeowners insurance premium and property taxes, your lender breaks up the total into 12 monthly payments. That amount is then rolled into your monthly mortgage payment.

For example, say your annual homeowners insurance premium is $1,000 and your annual county property tax is $2,500; the total comes to $3,500 a year. To make sure you set aside enough money to pay those two important bills, your lender adds an extra $292 to your mortgage payment and then handles making the payments for you. Your principal, interest, taxes and insurance are abbreviated as “PITI” and make up most — if not all — of your payment.

As time passes, your homeowners insurance premium may change, which means the amount you contribute to your escrow account may change as well. If your premium drops, you may not have to pay as much. But if it increases, you’ll have to pay more into your escrow account each month. Not all lenders set up escrow accounts and make insurance payments on your behalf, however, so verify your responsibility before closing on a home.

How to set up an escrow payment

Your role in setting up an escrow account is limited if your lender is handling it on your behalf. In most cases, the mortgage service takes care of it for the duration of your loan, starting on closing day. Pay attention to any loan documents you receive on closing and afterwards. Some lenders sell your mortgage to a servicer right away, and you’ll receive a letter in the mail with new payment instructions. This can be confusing, but it’s not uncommon. If you are setting up your own escrow account, expect to follow these steps:

  • Choose a financial institution.
  • Make monthly deposits based on your annual premium.
  • Setup automatic drafts with your homeowners insurance company based on your due date.

Do I have to pay homeowners insurance through escrow?

Whether or not you’re required to use an escrow account depends on the type of home loan you take out and the size of your down payment. For a conventional loan, you typically need at least a 20% down payment to opt out of escrow. A VA loan requires a minimum 10% down payment to opt out, as well as a solid credit score. FHA loans are the strictest and require you to use an escrow account for your taxes and insurance no matter what. 

Of course, if you pay for your home in cash, or finish paying off your mortgage, you won’t need an escrow account. But you’ll still be responsible for your property taxes and should still continue with homeowners insurance coverage. It can still save you from financial hardship in the event some type of damage occurs, even if you don’t have a mortgage to worry about.

ProsCons
Payments conveniently included in your mortgage payment.Monthly mortgage payment could change based on change in premiums.
Mortgage servicer pays on your behalf.Mortgage servicer’s estimate could be incorrect, leaving you with either more or less money in your escrow account than you actually need.
No surprises with large annual premium payments.
No need to track due dates of multiple annual bills, including homeowners insurance and property taxes.
Typically receive a reimbursement if you contribute too much to your escrow account.

How to change homeowners insurance with escrow

Changing your homeowners insurance with an escrow account is fairly easy, regardless of whether it’s at the end of your policy or in the middle of it. Once you change a new policy and cancel your old one, simply let the new insurer know who your mortgage servicer is and give them any required details. Your mortgage service will then make any required payments directly out of your escrow account.

If you end your old policy early, you may receive a refund check directly from the insurer since you pay your annual premium for the upcoming year in advance. The amount will be prorated based on how many remaining months are left unused on your policy. 

Your mortgage servicer should pay the new company directly based on your escrow funds. You may need to pay a lump sum or have an additional fee added to your monthly mortgage payment if there’s not enough cash in your account. Finally, your mortgage payment could change based on whether your new premium is higher or lower than the previous one.

The takeaway

  • An escrow account is set up to manage homeowners insurance payments on your behalf.
  • Only certain mortgages require an escrow account.
  • It’s easy to change homeowners insurance even with an escrow account.

Conclusion

An escrow account can be an effective way to manage your annual homeowners insurance premium. While your monthly mortgage payment may fluctuate based on changes in your premium, you’re in charge of choosing the best coverage at the right price. Once you’ve settled on a provider and taken care of up-front fees, your escrow account will take care of recurring payments.

Lauren Ward

Lauren Ward is a writer for Coverage.com. She specializes in all things personal finance, including insurance, loans, and real estate.

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