How does home insurance and escrow work?

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When you buy a home, your mortgage lender takes a financial interest in your home. Your lender will create and manage an escrow account on your behalf to ensure that certain major recurring expenses are paid on time.

Here’s what you need to know about home insurance and escrow:

What is a home insurance escrow account?

A mortgage escrow account holds money in reserve for home expenses — like home insurance and property taxes — that you pay as part of your mortgage payment. The account is established when you close your home, with funds you pay as part of your closing costs. Your mortgage company or managing agent manages the account and pays bills on your behalf when they are due.

Having an escrow account helps you budget for these expenses by combining them into one PITI mortgage payment (principal, interest, taxes, insurance). It also gives your lender the confidence that makes your home loan less risky for your lender by guaranteeing that the necessary expenses will be paid.

Home insurance is a home-related bill usually paid from an escrow account.

Once you have started making your monthly mortgage payments, your lender or mortgage agent will place a predetermined amount of each payment into your insurance escrow. Then, when your home insurance premium is due, the lender will pay it from this escrow account on your behalf.

How does home insurance escrow work?

Mortgage lenders make home insurance a closing condition of a home sale, so you’ll likely have to pay a premium at some point during the closing process.

If you choose – or are required to – pay for part of your home 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 reaches deadline.

Good to know: You will likely pay at least two months of premiums into your escrow account at closing. This is a cushion for the first premium payment due after closing.

The lender will divide your annual insurance premium by 12 to calculate the amount you will 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 home insurance cost?

Advantages and disadvantages of home insurance escrow

An escrow account offers certain advantages, but it also has certain disadvantages.

Advantages

The main benefit of an insurance escrow is that it saves you from having to remember to make your home insurance payment. Other ways escrow can help include:

  • A payment : You only have one payment to make on your home, making budgeting easy.
  • Simple to manage: Monthly contributions to your escrow account help manage payments versus annual lump sum payments.
  • Adapt more easily to premium increases: You will usually have a few months of insurance payments in reserve, giving you time to adjust to price increases.

The inconvenients

Be sure to consider the following drawbacks if you must use an escrow account to pay your insurance premiums:

  • Increase your monthly payment: Breaking up your home insurance premium and property taxes into smaller payments throughout the year makes them easier to manage, but it also means a larger monthly payment.
  • Estimate misstatements: Your escrow payments cover the lender’s estimate of your annual insurance premium. Your mortgage payment will increase if the premium increases or if your lender provides an inaccurate estimate.
  • Not infallible: You will still need to meet your payment due dates and your escrow account disbursements to ensure the premium is paid.

Should I buy home insurance after paying off my mortgage?

You are free to end your home insurance policy once your mortgage is paid off. But before you do, it’s important to consider the potential consequences if you leave your home uninsured.

Home insurance covers both the structure and contents of your home against losses caused by fire, theft, vandalism and many other perils. It also pays for accommodation while your home is being repaired or rebuilt if it has been damaged by a covered event.

Additionally, standard homeowners insurance policies include liability coverage that can pay for medical treatment in the event someone is injured on your property – and cover your legal costs in the event of a lawsuit. It even covers damage that you, your family members or your pets cause to other people or their property.

Good to know: That said, there are certain steps you should follow once you’ve fully paid off your mortgage. First, contact your insurer to remove the mortgage lender from your policy – they’re probably listed as an additional insured.

Then review your coverage to make sure it still meets your needs. Shopping around to check rates from multiple companies will ensure you get the best coverage at the right price.

Learn more: Is home insurance compulsory?

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Home Insurance Escrow FAQs

Here are answers to some frequently asked questions about home insurance and escrow accounts:

What if the lender does not pay on time?

If the lender pays late or misses a payment, they are liable for penalties imposed by the insurance provider. Contact the lender or service agent to resolve the issue in a timely manner.

In the event that a late or missed payment causes your policy to be voided, your lender must contact the insurer to reinstate the policy or purchase a new policy on your behalf, according to the Office of the Comptroller of the Currency.

How do you decide which home insurance to use?

Your mortgage lender will tell you what type of insurance they require you to have: actual cash value, which covers the depreciated value of your home and belongings, or replacement cost, which covers the full cost repairs or replacement.

Next, determine the amount of coverage you need based on the value of your home and property, then get quotes from multiple insurers to compare rates.

Check: Home insurance replacement cost vs. actual cash value

What if I want to change home insurance company?

Once you have selected a new insurer and a new policy, select an effective date for the new policy and check the effective time. Then contact your current home insurance company to request that your current policy be canceled as of that date and time.

Don’t forget to contact your lender to inform them of the change in insurance policy before it takes effect. You may need to provide a written declaration and your new declarations page to verify your latest coverage.

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Disclaimer: All insurance related services are provided by Young Alfred.

About the Author

Daria Uhlig

Daria Uhlig is a Credible contributor who covers mortgages and real estate. His work has appeared in publications such as The Motley Fool, USA Today, MSN Money, CNBC and Yahoo! Finance.

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