Author Topic: Pay Down Mortgage to Eliminate Escrow Account?  (Read 4664 times)

AlwaysLearningToSave

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Pay Down Mortgage to Eliminate Escrow Account?
« on: March 03, 2016, 02:49:27 PM »
We bought our house before discovering MMM and stupidly did so without a 20% down payment, thus requiring PMI.  [Ducks first attempted facepunch].  When we did so we chose to pay the PMI premium upfront because it is cheaper after about three years of payments.  [Willingly accepts a slightly less hard facepunch].  The lender required setting up an escrow account to hold funds for real estate taxes and homeowners' insurance.  The escrow portion of my monthly payment is currently $363.11.  Principal/interest payments are $822 (30 year fixed mortgage, original principal balance was about $162,000 at 4.5%).  Loan to Value ratio is currently about 88%, using assessed value. 

I recently asked whether it would be possible to eliminate the escrow account.  The lender indicated that the escrow account requirement is tied to the PMI requirement and that the escrow account therefore cannot be eliminated until the loan to value ratio reaches 78%.  Thus, the bank continues to gain the benefit of the time value of my money, which irritates me. 

I'm wondering whether it would make sense to make additional mortgage payments to get the loan down the point where we can eliminate the escrow account but I'm having trouble thinking about how to analyze the value of doing so.  Since we already paid the entire PMI premium, that is a sunk cost and I get no PMI savings by making additional payments.  We would only get the benefit of the time value of the monthly escrow payment, which is not pure savings because we still have to pay taxes and insurance.  We also do not make enough money to have post tax money left over after maxing out tax-advantaged retirement accounts.  Thus, any funds that we used to make extra payments on the mortgage would be taking away from tax-advantaged retirement accounts.  Assume a combined state and federal marginal tax rate of 22%.  How do I weigh the time value of the escrow payments and interest savings of extra principal payments versus the value of the tax advantaged savings I would be foregoing?

My hunch is that I should not make the extra payments toward mortgage principal but I'm not quite sure how to go about doing the math.  What do you all think?

GrowingTheGreen

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Re: Pay Down Mortgage to Eliminate Escrow Account?
« Reply #1 on: March 03, 2016, 05:13:14 PM »
You're actually the first person I've encountered who thought about this--myself included!

Short answer is no. You are highly likely to beat your 4.5% mortgage by investing in stock mutual funds. It isn't really worth it just to hang on to your $363/month a wee bit longer. You would probably (read: you should) be holding it in a measly 1% savings account since you'll need it in the very near future to pay your insurance and property tax bills.

AlwaysLearningToSave

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Re: Pay Down Mortgage to Eliminate Escrow Account?
« Reply #2 on: March 03, 2016, 06:57:28 PM »
My counter to that thinking would be that I likely wouldn't need to set money aside specifically for taxes and insurance premiums. I would invest the 360ish per month and then use current income to pay the tax and insurance bills when they come due. I have a high enough savings rate that cash flowing the payments without using a savings account would be no problem provided I don't have other outsized expenses the same month. So I would likely be getting more than a 1% return. I will certainly do it whenever I'm able to get rid of the escrow, but I'm not convinced it would be worth it to accelerate the mortgage payment to get there. I just bugs the hell out of me that I'm giving the bank my money every month.

Ricksun

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Re: Pay Down Mortgage to Eliminate Escrow Account?
« Reply #3 on: March 04, 2016, 06:49:26 AM »
My escrow account frequently goes into the negative because my assessment keeps rising and it's become a game of catch up, so my "lost" time value of money is not as bad as yours likely...  That being said, it's nice not to have to even think about making the payment; although I still have to challenge my assessment pretty much every year.  Probably not worth the effort in my opinion for the little gain, especially if you're considering paying down extra principal.


NoStacheOhio

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Re: Pay Down Mortgage to Eliminate Escrow Account?
« Reply #4 on: March 04, 2016, 07:18:11 AM »
Probably not worth the effort in my opinion for the little gain, especially if you're considering paying down extra principal.

+1

We have escrow without PMI (lender wanted it), and it doesn't particularly bother me. It isn't a huge amount of money, and I'd be writing a tax check twice a year anyway. Homeowners insurance is cheap enough that I don't care, especially since they usually charge extra for paying monthly.

Since the PMI is a sunk cost, I wouldn't spend time/energy worrying about the escrow.

neo von retorch

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Re: Pay Down Mortgage to Eliminate Escrow Account?
« Reply #5 on: March 04, 2016, 07:32:58 AM »
My insurance company gives us a roughly 10-12% discount on homeowner's insurance while our premium is paid by the bank through escrow. You might want to look into that before pulling the plug on the escrow. Once you're investing and cash-flowing tax payments, the investment potential might outstrip that premium difference anyway, but at least know if that's a thing for you in advance.

AlwaysLearningToSave

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Re: Pay Down Mortgage to Eliminate Escrow Account?
« Reply #6 on: March 04, 2016, 09:06:48 AM »
My insurance company gives us a roughly 10-12% discount on homeowner's insurance while our premium is paid by the bank through escrow. You might want to look into that before pulling the plug on the escrow. Once you're investing and cash-flowing tax payments, the investment potential might outstrip that premium difference anyway, but at least know if that's a thing for you in advance.

That is something I hadn't considered and I don't know whether my insurer does that.

Thanks for the replies everyone. Seems to me the best course is to not accelerate mortgage payments.

gardeningandgreen

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Re: Pay Down Mortgage to Eliminate Escrow Account?
« Reply #7 on: March 04, 2016, 09:11:02 AM »
You may be able to get rid of the escrow and refinance at a lower rate therefore essentially getting rid of that higher rate that was going to be a sunk cost due to PMI. It also depends on how much your home has appreciated. If you think you might still be able to be under the 80% LTV with appreciation it might be something to look into.

bearkat

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Re: Pay Down Mortgage to Eliminate Escrow Account?
« Reply #8 on: March 04, 2016, 09:47:17 AM »
Quote
We also do not make enough money to have post tax money left over after maxing out tax-advantaged retirement accounts.  Thus, any funds that we used to make extra payments on the mortgage would be taking away from tax-advantaged retirement accounts.

Quote
My counter to that thinking would be that I likely wouldn't need to set money aside specifically for taxes and insurance premiums. I would invest the 360ish per month and then use current income to pay the tax and insurance bills when they come due. I have a high enough savings rate that cash flowing the payments without using a savings account would be no problem

I'm confused. You don't have enough savings to accelerate your mortgage pay down without taking it from tax-advantaged accounts... And yet (after escrow account is gone) the plan is to invest that extra $360/mo. and cash flow the taxes and insurance payments?

What am I missing?

dogboyslim

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Re: Pay Down Mortgage to Eliminate Escrow Account?
« Reply #9 on: March 04, 2016, 09:47:52 AM »
My insurance company gives us a roughly 10-12% discount on homeowner's insurance while our premium is paid by the bank through escrow. You might want to look into that before pulling the plug on the escrow. Once you're investing and cash-flowing tax payments, the investment potential might outstrip that premium difference anyway, but at least know if that's a thing for you in advance.

Most companies will give a similar discount for premiums paid in full rather than on a payment plan.

neo von retorch

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Re: Pay Down Mortgage to Eliminate Escrow Account?
« Reply #10 on: March 04, 2016, 09:58:42 AM »
Yes - asked about that. In this case... paid monthly by homeowner -> paid annually by homeowner -> paid annually by bank. So the least expensive option for us, is let the bank handle it. That being said, we will probably still take over tax and insurance payments down the road, like OP, and invest that money, and then cashflow tax and insurance payments as needed.

AlwaysLearningToSave

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Re: Pay Down Mortgage to Eliminate Escrow Account?
« Reply #11 on: March 04, 2016, 12:26:04 PM »
Quote
We also do not make enough money to have post tax money left over after maxing out tax-advantaged retirement accounts.  Thus, any funds that we used to make extra payments on the mortgage would be taking away from tax-advantaged retirement accounts.

Quote
My counter to that thinking would be that I likely wouldn't need to set money aside specifically for taxes and insurance premiums. I would invest the 360ish per month and then use current income to pay the tax and insurance bills when they come due. I have a high enough savings rate that cash flowing the payments without using a savings account would be no problem

I'm confused. You don't have enough savings to accelerate your mortgage pay down without taking it from tax-advantaged accounts... And yet (after escrow account is gone) the plan is to invest that extra $360/mo. and cash flow the taxes and insurance payments?

What am I missing?

I'm not sure what you are missing. 

If the escrow account did not exist, I would be able to capture the time value of the money that I currently pay to the bank each month by investing it.  That way I can earn a (theoretically) better return than the 0% return I currently get from the bank.  In the months that a tax payment or insurance premium are due, I would pay them with current income.  Seems like doing this is a no-brainer if you are able to eliminate the escrow account and have sufficient cashflow to pay everything with current income when it comes due (assuming insurance premiums don't increase due to lack of an escrow account). 

The problem is that my lender won't eliminate the escrow account until the outstanding balance on the loan reaches a certain threshold.  My question is whether it would make sense to accelerate mortgage payments to try to get to the point of eliminating the escrow account sooner than if I just made minimum payments.  If I made extra payments on the mortgage, I would be doing so in lieu of investing in tax advantaged accounts because I don't make enough to both max out tax advantaged accounts and make extra mortgage payments.  My gut reaction, confirmed by the collective wisdom of the others who replied, is that it probably does not make sense to accelerate the mortgage payments in my circumstance. 

Any clearer? 


AZDude

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Re: Pay Down Mortgage to Eliminate Escrow Account?
« Reply #12 on: March 04, 2016, 12:39:55 PM »
Wait, you paid *all* of the PMI premiums upfront? For the whole 30 years, or just for 3 years?

neo von retorch

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Re: Pay Down Mortgage to Eliminate Escrow Account?
« Reply #13 on: March 04, 2016, 01:02:36 PM »
I'm going to reiterate bearkat's question...

You spend "every last cent" currently on your mortgage (which includes escrow) and "contributing to tax-advantaged accounts."

Once you stop having escrow, you'll have $360 additional cash, but still throw the rest of your money in tax-advantaged accounts. Once you put that $360 into investments, how will you have the money you need to pay city and school tax and hazard insurance, in lump sums? Will you be reducing your contributions to tax-advantaged accounts?

AlwaysLearningToSave

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Re: Pay Down Mortgage to Eliminate Escrow Account?
« Reply #14 on: March 04, 2016, 01:04:02 PM »
Wait, you paid *all* of the PMI premiums upfront? For the whole 30 years, or just for 3 years?

Yes. 

It was a conventional mortgage so PMI was not required for the full 30 years.  It was required until (if I remember correctly) the loan to value ratio equals 78% or the outstanding principal balance reached 80% of the original loan value.  With no extra payments, I would reach that point about 10 years into the 30 year amortization period.  You can choose to pay PMI monthly or in one premium payment.  It was significantly less expensive to pay up front than to pay monthly.  The break-even point was at about three years into the mortgage, so you reap the benefits of the upfront payment in years 4 through 10. 

Of course the smart thing to do is not buy a house until you can afford to put 20% down.  I was young and stupid then.  Now I'm older :-)

AlwaysLearningToSave

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Re: Pay Down Mortgage to Eliminate Escrow Account?
« Reply #15 on: March 04, 2016, 01:28:09 PM »
I'm going to reiterate bearkat's question...

You spend "every last cent" currently on your mortgage (which includes escrow) and "contributing to tax-advantaged accounts."

Once you stop having escrow, you'll have $360 additional cash, but still throw the rest of your money in tax-advantaged accounts. Once you put that $360 into investments, how will you have the money you need to pay city and school tax and hazard insurance, in lump sums? Will you be reducing your contributions to tax-advantaged accounts?

In a month when a bill is due, I would pay the bill with income earned that month which would mean I would make a smaller investment that month.

Assume that I currently invest $XX each month.  If the escrow account did not exist, I would be able to invest an amount equal to $XX + $360 each month, except for months when taxes or insurance premiums are paid.  In months where tax payments or insurance premiums were due, I would be able to invest $XX - [payment amount].  Thus, my monthly savings rate would be significantly lower in the three months of the year in which I used earned income to make a tax or insurance payment, but would be significantly higher the other nine months.  My annual savings rate would remain unchanged (assuming taxes and insurance premiums remain constant).  The benefit is that I would be able to capture earnings on the extra $360 per month between the time I invest it and the time I make the tax payment with earned income.  The extra earnings from investing the $360 per month would likely not be that significant in the short term, but over the 30 year life of a mortgage would not be insubstantial.
« Last Edit: March 04, 2016, 01:55:33 PM by AlwaysLearningToSave »

AZDude

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Re: Pay Down Mortgage to Eliminate Escrow Account?
« Reply #16 on: March 04, 2016, 01:43:27 PM »
Wait, you paid *all* of the PMI premiums upfront? For the whole 30 years, or just for 3 years?

Yes. 

It was a conventional mortgage so PMI was not required for the full 30 years.  It was required until (if I remember correctly) the loan to value ratio equals 78% or the outstanding principal balance reached 80% of the original loan value.  With no extra payments, I would reach that point about 10 years into the 30 year amortization period.  You can choose to pay PMI monthly or in one premium payment.  It was significantly less expensive to pay up front than to pay monthly.  The break-even point was at about three years into the mortgage, so you reap the benefits of the upfront payment in years 4 through 10. 

Of course the smart thing to do is not buy a house until you can afford to put 20% down.  I was young and stupid then.  Now I'm older :-)

I see. Well, I'm seeing an optimistic savings of like $80 a year from not having the escrow account, so I would probably just let it go and use the convenience of the account.

AlwaysLearningToSave

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Re: Pay Down Mortgage to Eliminate Escrow Account?
« Reply #17 on: March 04, 2016, 03:33:19 PM »
Wait, you paid *all* of the PMI premiums upfront? For the whole 30 years, or just for 3 years?

Yes. 

It was a conventional mortgage so PMI was not required for the full 30 years.  It was required until (if I remember correctly) the loan to value ratio equals 78% or the outstanding principal balance reached 80% of the original loan value.  With no extra payments, I would reach that point about 10 years into the 30 year amortization period.  You can choose to pay PMI monthly or in one premium payment.  It was significantly less expensive to pay up front than to pay monthly.  The break-even point was at about three years into the mortgage, so you reap the benefits of the upfront payment in years 4 through 10. 

Of course the smart thing to do is not buy a house until you can afford to put 20% down.  I was young and stupid then.  Now I'm older :-)

I see. Well, I'm seeing an optimistic savings of like $80 a year from not having the escrow account, so I would probably just let it go and use the convenience of the account.

Look at it this way:  You can earn $80 just by writing three check per year instead of twelve.

I'm imagining the conversation of the bankers who first thought of this:

Banker 1:  I bet people would be willing to give us an interest-free loan every month for the convenience of us making the payment for them.  It's practically zero extra effort for us.
Banker 2:  Great idea!  Then we can pocket the earnings on that money.  If we get 1000 people to sign up to do this, that's about $80,000 a year in extra income from other people's money for hardly any extra effort.
Banker 3:  Better yet, let's just write it into the contract and make people opt out of it.  If we just say "It's standard" they won't think twice about it.  I bet we can eventually get darn near every mortgage customer to sign up.
Banker 4:  That will also reduce our overhead costs because when it will be less likely someone stops paying insurance and we get stuck with the loss when their house burns down. 

If only I could have been in on that deal...


teen persuasion

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Re: Pay Down Mortgage to Eliminate Escrow Account?
« Reply #18 on: March 04, 2016, 05:01:11 PM »
Wait, you paid *all* of the PMI premiums upfront? For the whole 30 years, or just for 3 years?

Yes. 

It was a conventional mortgage so PMI was not required for the full 30 years.  It was required until (if I remember correctly) the loan to value ratio equals 78% or the outstanding principal balance reached 80% of the original loan value.  With no extra payments, I would reach that point about 10 years into the 30 year amortization period.  You can choose to pay PMI monthly or in one premium payment.  It was significantly less expensive to pay up front than to pay monthly.  The break-even point was at about three years into the mortgage, so you reap the benefits of the upfront payment in years 4 through 10. 

Of course the smart thing to do is not buy a house until you can afford to put 20% down.  I was young and stupid then.  Now I'm older :-)

I see. Well, I'm seeing an optimistic savings of like $80 a year from not having the escrow account, so I would probably just let it go and use the convenience of the account.

Look at it this way:  You can earn $80 just by writing three check per year instead of twelve.

I'm imagining the conversation of the bankers who first thought of this:

Banker 1:  I bet people would be willing to give us an interest-free loan every month for the convenience of us making the payment for them.  It's practically zero extra effort for us.
Banker 2:  Great idea!  Then we can pocket the earnings on that money.  If we get 1000 people to sign up to do this, that's about $80,000 a year in extra income from other people's money for hardly any extra effort.
Banker 3:  Better yet, let's just write it into the contract and make people opt out of it.  If we just say "It's standard" they won't think twice about it.  I bet we can eventually get darn near every mortgage customer to sign up.
Banker 4:  That will also reduce our overhead costs because when it will be less likely someone stops paying insurance and we get stuck with the loss when their house burns down. 

If only I could have been in on that deal...

Or ... the bankers didn't want the underlying asset (your house) to possibly be lost due to tax auction or property loss due to unpaid tax or insurance bills.  Bundle it all into the mortgage payment and everyone is covered, and many people feel it is an advantage.

I remember there were interest payments to our escrow account each year. 

The only reason I wished to get rid of it was when they neglected to pay the insurance, and the annual ring-around-the-rosy dance when they tried to predict next year's tax bill right before receiving this year's school tax bill.  Up, then down, then up, then down...

bearkat

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Re: Pay Down Mortgage to Eliminate Escrow Account?
« Reply #19 on: March 12, 2016, 07:52:49 AM »
I'm going to reiterate bearkat's question...

You spend "every last cent" currently on your mortgage (which includes escrow) and "contributing to tax-advantaged accounts."

Once you stop having escrow, you'll have $360 additional cash, but still throw the rest of your money in tax-advantaged accounts. Once you put that $360 into investments, how will you have the money you need to pay city and school tax and hazard insurance, in lump sums? Will you be reducing your contributions to tax-advantaged accounts?

In a month when a bill is due, I would pay the bill with income earned that month which would mean I would make a smaller investment that month.

Assume that I currently invest $XX each month.  If the escrow account did not exist, I would be able to invest an amount equal to $XX + $360 each month, except for months when taxes or insurance premiums are paid.  In months where tax payments or insurance premiums were due, I would be able to invest $XX - [payment amount].  Thus, my monthly savings rate would be significantly lower in the three months of the year in which I used earned income to make a tax or insurance payment, but would be significantly higher the other nine months.  My annual savings rate would remain unchanged (assuming taxes and insurance premiums remain constant).  The benefit is that I would be able to capture earnings on the extra $360 per month between the time I invest it and the time I make the tax payment with earned income.  The extra earnings from investing the $360 per month would likely not be that significant in the short term, but over the 30 year life of a mortgage would not be insubstantial.

Thanks for clarifying.

That said, here's what I seeing:

If you pay out $360 / yr to escrow (total of $4,320) currently, you could (simplistically) turn that into 3 payments of $1,440 every 4 months by eschewing the escrow account. I see that as having $720 ($1,440/2) invested an extra 2 months, 3x / year. If you assume a 5% real rate of return ($36/yr on $720), that nets you $6 for every 2 months. You can do this 3 times a year, so a total gain of $18 / year. After 10 years of this, you would have an extra $234 (again with 5% real return). I could only hope that in 10 years the extra $234 will be a rounding error in your account balances.*

I personally wouldn't go through the hassle for <$2/month, but I also don't sweat the small stuff, front-load tax advantaged accounts, or perform the IRA horse race (link: http://www.madfientist.com/roth-ira-horse-race/).

*note: please check my assumptions and calculations as they could easily be wrong.