Changing My Home Insurance: How does it affect my Escrow Account?
While homeowners insurance isn’t required by law, if you have a mortgage, your lender will mandate that you carry it. This is to protect their investment in your property. If you fail to maintain homeowners insurance, your lender will place a policy on your home known as "forced-placed insurance," which is typically more expensive and provides limited coverage.
When you select an insurance carrier, your mortgage company typically saves a portion of your monthly mortgage payment in an escrow account. This account is used to pay your property taxes and homeowners insurance annually. This process is often referred to as PITI (Principal, Interest, Taxes, and Insurance). By doing this, you avoid the need to save separately to cover these large annual expenses.
What Happens When You Switch Insurance Carriers?
If you decide to switch insurance companies, your mortgage company needs to be notified of the change. They will send a payment to your new insurance carrier to ensure your coverage remains current. However, this can lead to a temporary shortage in your escrow account, similar to a negative balance in a checking account.
After you cancel your previous policy, your former insurance carrier will issue a pro-rated refund of the unused premium, but this refund is sent directly to you, not to your mortgage company.
What Should You Do with the Refund Check?
Option 1: Cash the Check and Keep the Funds
While this might be tempting, we do not recommend it from a budgeting perspective. When your escrow account is reviewed at the end of the year, your mortgage company will notice the shortage and increase your monthly payments to compensate. This will result in a higher mortgage payment.
Option 2: Return the Refund to Your Mortgage Company
We highly recommend this option. When you receive the refund check, set the money aside and send it back to your mortgage company as an additional escrow deposit. Be sure to notify them that this payment is intended to replenish your escrow account. If not properly noted, they might apply it to your principal balance, which will still result in an escrow shortage and higher monthly payments in the future.