Unless you have 20% or more of equity in your home, chances are you have an escrow account (also referred to impounds or reserves) for your home owners insurance and property taxes. Lenders want to make sure that they reduce risk by requiring taxes and insurance to be included in your monthly mortgage payment. Property taxes are one of the few items that can take precedence over lien position in the event they were to not be paid. Your first mortgage wants to stay just that, a first mortgage (in the event of a worse case scenario, foreclosure).
A few years ago, there were a few lenders (subprime) who were providing 80/20 mortgages (100% financing) and not requiring that taxes and insurance be included in the payments. This was a disaster. A majority of these borrowers did not plan for the huge tax bills (on a $350,000 valued home, taxes would be roughly $4,375 annually) even though they had the best intentions of doing so.
Having your taxes and insurance included in your mortgage payment is actually very convenient. Instead of having to pay an annual insurance premium and half of your annual taxes on April 30th and the second half on October 31st, the lender establishes an automatic savings plan for you.
In addition, most lenders charge a fee when you pay your own taxes and insurance (or waive your reserve account). Typically, the fee is 0.25% of the loan amount. For example, on a $250,000 loan amount, the fee is $625.00 of additional cost. This can either be charged upfront as an escrow waiver fee or may be priced into the interest rate depending on pricing when the loan is locked. The most it should impact the rate would be by approx. 0.125%, which is about $20.00 more per month on a $250,000 loan. So you may be getting better pricing having your taxes and insurance included in the mortgage payment.
The amount of reserves the lender requires varies depending on the closing date of the new mortgage. Property tax reserves are based on what month your first payment is due and interest on the new mortgage is prorated to the day of closing. If you’re buying, 14 months of home owners insurance is collected. If you have a condo, the lender does not collect home owners insurance (but you should check into insurance for your belongings).
In my opinion, the only time it makes sense for home owners to not have their taxes and insurance included in their mortgage payment is when they are savvy investors who are going to earn enough interest in a short period of time (remember, taxes are paid twice a year) and still come out ahead of the costs (possibly 0.25% of the loan amount). Even if you have 20% or more equity in your home, I don’t recommend waiving your reserve account.
PS: There is a compromise to waiving your reserve account when you have at least 20% down payment, you may be able to waive your home owners insurance and just have property taxes included in your payment.
NOTE: This information is intended for properties in Washington State. Check with your Mortgage Professional to see how impounds are treated in your specific state.