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You have two primary choices for where to put your extra mortgage payments: principal or escrow. Before choosing one, it’s critical to recognize the differences between the two options because each has pros and cons of its own.
Understanding Escrow
Escrow is a third-party account that holds funds for property taxes, homeowners insurance, and other fees associated with your mortgage Your lender typically collects these funds along with your monthly mortgage payment and uses them to pay these bills on your behalf
Benefits of paying into escrow:
- Convenience: You don’t have to worry about remembering to pay these bills yourself.
- Budgeting: Escrow payments are spread out over the year, making them easier to budget for.
- Protection: If you forget to pay your property taxes or homeowners insurance, your lender will use the funds in your escrow account to cover the payments, preventing you from falling behind.
Drawbacks of paying into escrow:
- Interest: The funds in your escrow account are not earning interest, so you’re essentially giving up the opportunity to earn a return on your money.
- Potential for overpayment: If your property taxes or homeowners insurance decrease, you may end up overpaying into your escrow account.
- Limited control: You don’t have control over how the funds in your escrow account are used.
Understanding Principal
Principal is the amount of money you borrowed to purchase your home. You are actually lowering the amount you owe on your mortgage when you make a payment toward your principal.
Benefits of paying down your principal:
- Saves money on interest: The faster you pay down your principal, the less interest you’ll pay over the life of your loan.
- Builds equity: As you pay down your principal, you’re building equity in your home. Equity is the difference between the market value of your home and the amount you owe on your mortgage.
- Reduces the length of your loan: Paying down your principal can help you pay off your mortgage faster, saving you money on interest and allowing you to build equity more quickly.
Drawbacks of paying down your principal:
- Less flexibility: If you need to access the funds in your escrow account for an emergency, you may not be able to do so if you’ve been paying down your principal.
- Higher monthly payments: If you choose to pay extra towards your principal, your monthly mortgage payments will be higher.
So, which is better: paying off escrow or principal?
The answer depends on your individual circumstances and financial goals. If you’re looking to save money on interest and build equity in your home as quickly as possible, then paying down your principal is the better option. However, if you prefer the convenience and peace of mind that comes with having an escrow account, then paying into escrow may be the right choice for you.
Here are some additional factors to consider when making your decision:
- Your interest rate: If you have a high interest rate, paying down your principal will save you more money on interest than paying into escrow.
- Your financial situation: If you have a stable income and are comfortable with making higher monthly payments, then paying down your principal may be a good option. However, if you’re on a tight budget, then paying into escrow may be a better choice.
- Your risk tolerance: If you’re comfortable with taking on a little more risk, then paying down your principal may be the right choice for you. However, if you prefer to play it safe, then paying into escrow may be a better option.
The choice of whether to pay off principal or escrow is ultimately a personal one. There is no right or wrong response; instead, the best course of action for you will rely on your unique situation and financial objectives.
Additional Resources
- Citrus Heritage Escrow: https://www.citrusheritageescrow.com/should-i-pay-my-principal-or-escrow-first/
- ATG Title: https://atgtitle.com/should-you-pay-a-mortgage-principal-or-escrow-first/
Frequently Asked Questions
- What is escrow?
Escrow is a third-party account that is used to hold money for homeowners insurance, property taxes, and other mortgage-related expenses.
- What is principal?
Principal is the amount of money you borrowed to purchase your home.
- Which is better: paying off escrow or principal?
The answer depends on your individual circumstances and financial goals. If you’re looking to save money on interest and build equity in your home as quickly as possible, then paying down your principal is the better option. However, if you prefer the convenience and peace of mind that comes with having an escrow account, then paying into escrow may be the right choice for you.
- How can I decide which option is right for me?
Consider your interest rate, financial situation, and risk tolerance when making your decision. You may also want to talk to a financial advisor for personalized advice.
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Cons of a mortgage escrow account
Although it is convenient to not have to worry about remembering to make different payments on time, organized homeowners who would rather have complete control over their payments may find that this benefit becomes a disadvantage. A lot of mortgage lenders let homeowners pay their homeowners insurance directly to the provider and their property taxes directly to the county assessor.