# 4 Understand Insurance and Property Tax Escrow Accounts

Lenders and closers love to talk about it, but what does it mean really? There are a couple of things they may be referring to. My old mortgage payment, due on December 1st has a 15 day grace period to pay it. If my loan is closed and funded before that grace period is up, technically I don’t have to make the payment. But you better believe the bank isn’t going to make the payment. That principal, as well as the interest, will just be added onto the loan (and your payoff amount will be higher).

First, I closed my loan in the first half of December

The second thing the lender may be referring to is the fact that I won’t make a January payment. While it is true that I don’t have to write a check in January, there really isn’t any savings going on. Again, no one else is going to make the payment for me. The reason I don’t make a payment in January is that I made it at closing. That’s right. Not only do you not skip a payment, you have to make it IN ADVANCE. That’s because interest is collected in arrears. So at closing, you pay the interest for the first part of the month as part of the payoff amount (it’s usually added onto the loan, like in my case, but you could pay it with cash at closing if you like). You also pay the interest for the second part of the month as part of your closing costs. I paid the interest for December at closing, so I obviously won’t have to pay it again at the first of January. Interest never sleeps. From the day you take out a mortgage, until the day you pay it off, you’ll never stop accumulating interest on the amount owed, no matter how many times you refinance.

Now, what about the principal? I don’t HAVE to pay the principal in January. I can if I want, but I don’t HAVE to. So in reality, I CAN skip a principal payment. But do you think someone else pays it for me? Not hardly. So if I didn’t increase my payment after the refinance, it would take me another 15 years, plus another month to pay off the loan. Again, if I want the loan paid off after 15 total years in the house, I’d better pay the principal for January.

An escrow account is an account, usually held by your bank, that pays your insurance and property taxes. It’s helpful for those without the discipline to save up money for those large expenses themselves, and many lenders require you to have one, or at least make you pay a fee if you want to do it yourself. (Although you can often cancel your escrow account without a fee after you start making payments.) With an original mortgage, you usually need to put 2 months’ worth of pro-rated insurance and taxes in the escrow account. With a refinance , you’ll almost surely need to put in more, sometimes much more.

It just gets added on to the end of the loan

For example, I paid both my taxes and insurance in November, and so I only have 3 months of escrows in my old account (2 from the original buffer, plus the amount that was paid with my December mortgage payment). The bank, however, wanted 5 months’ worth of pro-rated insurance payments, and four months of pro-rated property tax payments. That’s the two buffer months, plus December and January for the taxes, and plus November, December, and January for the insurance (insurance was paid in early November, taxes in late November). I’ll get 3 months’ worth of escrow back from the old bank a few weeks after closing, but 4-5 months of escrow had to be fronted for the new escrow account at the new bank. Again, there is no skipped payment for interest OR escrows, and a skipped principal payment doesn’t help you.