Part of purchasing a home as a first-time homebuyer is learning a lot of new terminology. One of those terms is, “escrow.” There's a pretty good chance you’ve driven around town and seen the words "In Escrow" on a home and questioned what it meant, and potentially asked yourself, "Do VA loans require escrow?"
In this blog post, we'll look at what escrow is and how it impacts VA home loans.
Escrow is a legal arrangement where a third party temporarily holds this money or property until specific conditions outlined are met.
An escrow account will hold funds for insurance, taxes, etc., throughout the term of the mortgage. Escrow accounts are in place to protect both buyers and sellers of a home, and are typically used for two reasons: to protect the buyer’s good faith deposit and to hold funds for property taxes and homeowners insurance.
While the VA doesn’t require an escrow account for VA loans, your lender likely will. Lenders are required to ensure the property is sufficiently covered by hazard insurance and that property taxes are paid, which usually results in the use of an escrow account. Escrow accounts are a security measure on the lender’s part.
A VA loan escrow account refers to additional funds included with your monthly mortgage payments. This account is managed by a third party, and your lender uses these funds to pay for items such as homeowners insurance or property taxes. Your first escrow payment is typically due at closing.
Like many VA loan requirements, a VA loan escrow account isn't something the VA specifically requires—it's a mortgage lender requirement.
The VA requires lenders to guarantee that the property taxes are paid and adequate hazard insurance is in place on the home. This is because not paying either of these can hurt your home's overall value. A VA loan escrow account is the preferred method most lenders use to meet that requirement.
Like many other closing costs included in the VA homebuying process, you can ask the seller to pay some or even all of the buyer’s property tax and insurance premiums.
The Real Estate Settlement Procedures Act ("RESPA") protects home buyers and helps them understand the costs associated with buying a home. RESPA also helps prevent "hidden fees" tied to things like referrals, which can make closing your loan—and buying your home—more expensive.
RESPA's section 10 limits the amount lenders can require to be placed into escrow for fees such as homeowners insurance and property taxes. To determine the amount you’ll need to put into the escrow amount, your lender will take an average of previous property tax amounts and add your homeowner insurance premium. Then they divide that total by twelve to get your monthly VA loan escrow amount. This escrow amount will be included in your monthly mortgage payment.
For example, an average annual property tax bill of $2,400 and homeowners' insurance at $1,280 totals $3,680. After dividing this by 12 months, the monthly escrow portion of the mortgage payment would be approximately $306. Keep in mind that your lender or mortgage servicer evaluates your escrow account annually, meaning you could see an increase or decrease in that monthly amount.
RESPA requires your lender to issue a statement outlining your starting escrow balance as well as an annual breakdown detailing the year's payments.
Keep in mind that RESPA laws do not set a minimum deposit, sometimes referred to as a "cushion" amount. However, lenders can ask for funds equal to one-sixth of the total amount of items paid out of the account, or the equivalent of two months of escrow payments.
Whether you can waive escrows on a VA loan depends in part on the lender. This can be a solid financial move for some, and a bad financial move for others.
If you're comfortable managing your money, and holding on to the full amount of your property taxes until they are due, then waiving escrow may be a good choice for you. But the downside means having money in your account that you can't touch, regardless of the reason. That can be challenging for even the best budgeters.
It’s important to note that some lenders will only let you waive escrow once you have at least 20 percent equity in your home. And while waiving escrow on a VA loan reduces the amount of your monthly mortgage payment, it doesn't change the total amount of money you have to pay.
VA loan escrow accounts are often a part of the homebuying process However, just because you have no down payment doesn’t mean you're stuck with an escrow account forever.
It is sometimes possible to get a VA home loan without an escrow account. And if you currently have an escrow account, you may be able to remove it from your loan. For that, you’ll need a VA loan escrow waiver.
With a VA loan escrow waiver, you'll be responsible for ensuring you pay the bills, such as homeowners insurance and property taxes, on time and in full when they become due. This means making lump-sum payments for each expense, compared to paying out smaller amounts on a monthly basis.
It's important to note that your lender will probably revoke your escrow waiver if you get an escrow waiver but miss a payment—or pay less than the total amount owed. Your lender may also require that you establish a new escrow account for the duration of your VA home loan.
Each lender will have different requirements for obtaining a VA loan escrow waiver. However, common VA loan escrow waiver requirements can include:
Whether or not you decide to ask for a VA loan escrow waiver depends on your personal situation and the lender or servicer. Take some time to go over your finances and do some careful budgeting. While an escrow waiver might be risky for a homeowner with temporary or varying income streams, it might be the wise choice for strong budgeters. Talk with your bank, financial advisor or lender to get the information you need. There's no one right or wrong decision—there's only the best decision for you and your family.