When it comes to mortgage financing, “escrow” is a term that’s used much more often in the U.S. than in Canada. By definition, the word refers to funds that are held in trust for a third party. For example, many Canadian lenders use escrow accounts to collect and store property taxes on behalf of their mortgage clients. These accounts are commonly referred to as property tax accounts. Let’s take a closer look at how these escrow accounts are administered and when you can expect to have one opened on your behalf.
What’s An Escrow Account When Buying A House?
When you buy a house and take out a mortgage, one of the things you’re responsible for is paying the property taxes owed to the municipality on an annual basis. In many cases, you’ll be presented with the option of paying your own property taxes or choosing to have your lender collect them on your behalf as part of the mortgage payment and then sent to the municipality once per year.
If you choose to have your lender collect your taxes in escrow, your annual property tax amount will be separated into monthly or biweekly segments and collected with your regular mortgage payment. Whenever a payment is made, the tax portion will be placed into the escrow account.
Is There A Benefit To Having A Mortgage Escrow Account?
The main advantage of using an escrow account is convenience. If your mortgage lender is looking after your property tax payment, it’s one less thing you need to worry about – one less bill you have to remember to pay. In fact, prior to the tax payment due date, the municipality will send an invoice directly to your lender as well as a copy to you for your records.
Once the system is all set up, there’s virtually nothing you have to do. Another benefit is that by having your property taxes collected in small amounts on a bi weekly basis, it saves you from having to budget a large amount once a year.
Do I Have To Use A Mortgage Escrow Account?
In many cases, the use of an escrow account is optional; however, there are times when it will be a requirement of your lender. In the case of high ratio mortgages, or those with less than a 20% down payment, some lenders will insist on collecting and paying the client’s property taxes in escrow. Generally speaking, because there’s less equity in the home, there’s a perceived higher risk of default or of property taxes not being paid by the homeowner. If property taxes were to fall into arrears, it could place the lender in a position where the municipality would force a sale of the property, resulting in losses for the lender.
Alternatives To Escrow
If you aren’t required to use an escrow account for your mortgage and don’t wish to, you can opt to pay your property taxes to the municipality yourself. It means that you’ll either need to cut a large cheque once a year or be disciplined to save on a regular basis throughout the year so that the payment is available on the due date. Some people choose to use escrow to avoid having to worry about saving on their own.
What If There’s Not Enough Money In Escrow?
You may find yourself in a situation where there’s not enough money in escrow to cover the property taxes when they’re due. There are a few reasons that this situation may occur. For starters, if you’ve purchased a home shortly before the property tax deadline, your lender will not have had enough time to collect a full year’s worth of property tax payments. Another example would be a miscalculation of the periodic escrow payment, or an increase in property taxes owing that wasn’t accounted for in advance.
Regardless of the situation, most lenders will allow an escrow account to be in a negative balance for a period of time. After the property taxes are paid, if there’s a deficient balance, the periodic payment amount is adjusted higher to account for the shortfall. Clients are always notified in advance of any changes to the property tax payment being collected in escrow.
What Happens If There’s A Surplus Balance In Escrow?
Sometimes, there can be a situation where your lender has collected more money than is required to pay the property taxes, and you may end up with a surplus balance in your escrow account. This is usually the result of a simple oversight or miscalculation. If this happens, you can usually request that the surplus balance be refunded to your bank account. After all, there’s no point in having the money sit there. Another option would be to keep the surplus in the account and have your lender lower the property tax portion of your mortgage payment accordingly. This way, you can enjoy the lower mortgage payments until the surplus is fully used.
Do Escrow Funds Earn Interest?
Not all escrow accounts pay interest. It’s nice if they do, but it can be a drawback if they don’t. If you have the option, you may be better off collecting interest on your own rather than using an escrow account that doesn’t pay interest. It might not make much difference in 12 months, but over the life of the mortgage, the lost interest could add up.
Can I Cancel My Escrow Account?
If you’re currently using escrow, either by choice or due to a lender requirement, you may request to cancel the arrangement and pay your own property taxes. If it’s optional, it’s a very simple change to make. If it’s a lender requirement, you may be able to make a request, but there’s no guarantee of approval.
Final Thoughts On Escrow
If you’re buying a home in Canada, it’s possible that you’ll never hear the term “escrow” used by your lender when you’re setting up your mortgage. The more commonly used term is “property tax account.” But that’s OK. Now you know the connection between the two and understand exactly how escrow works in relation to your mortgage.
Tom Drake is an authority in Canadian personal finance. He is a financial analyst and has been writing about personal finance since 2009 at the award-winning MapleMoney. His work has appeared in MintLife, Canadian MoneySaver, and U.S. News & World Report, and has been quoted in The Globe and Mail, Yahoo Finance, and Financial Post.