Escrow for owner financing: collecting taxes and insurance with the payment
When you carry the note, the property is your collateral. If the buyer stops paying the property taxes or lets the insurance lapse, your security is what suffers. Escrow is the usual answer: the buyer pays a little extra with each payment, and the holder pays the tax and insurance bills from it. Here is how to run it on a seller-financed note.
Escrow, or the buyer pays the bills directly?
Your note and the documents signed at closing say which. There are two common arrangements:
- The buyer pays taxes and insurance directly and sends you proof each year: the paid tax receipt and the insurance declarations page, with you named on the policy. Less work for you, but you find out about a missed bill late.
- The buyer pays into escrow with each payment and you pay the bills. More work, but you know the taxes were paid and the policy is in force, because you paid them.
If the note says nothing, changing the arrangement later is a change to the deal, and both sides should agree to it in writing.
Working out the monthly escrow amount
Start from the bills the escrow has to cover in a year: the property tax bill, the insurance premium, and HOA dues if you have agreed to pay those too. Add them up and divide by twelve. That is the monthly escrow amount, and it is added to the principal and interest payment.
- Use the latest bills, not the ones from closing. Taxes and premiums both move, and usually up.
- Check it once a year. When the new tax bill or renewal arrives, compare twelve monthly amounts with what you actually paid out. If they fall short, raise the monthly amount and tell the buyer in writing before it changes.
- Watch the timing. Taxes are often due once a year. In the first year there may not be twelve deposits in escrow before the bill comes due, so the account can be short through no fault of the buyer.
Where to keep the escrow money
Escrow is the buyer's money set aside for the buyer's bills. Keep it out of your own spending: a separate bank account for each note's escrow, or at least one escrow account with a ledger per note, makes it easy to show what came in and what went out. Rules on holding escrow vary by state, so ask your lawyer if you are unsure.
Keeping the escrow ledger
Escrow needs its own ledger, apart from the payments on the loan. The part of each payment that goes to escrow is not interest and does not pay down the balance, so mixing it into the payment ledger throws the balance off. The escrow ledger records three things:
- Deposits: the escrow part of each payment, on the day it arrived.
- Bills paid: each tax bill, insurance premium or HOA payment, with the date, the payee and the amount.
- The balance: deposits less bills paid. If it goes below zero, you paid a bill before enough was collected, and the escrow is short.
At year end the buyer will want to know what was paid in property tax from escrow, and the payoff figure should show the escrow balance separately from what is owed on the loan, so nobody mistakes one for the other at closing.
When to let a servicer hold escrow instead
If you would rather not hold the buyer's money at all, a loan servicing company can collect the payment, hold escrow and pay the bills for you, for a fee. See loan servicing for owner financing for what to ask one.
How OwnerNote keeps escrow
In OwnerNote each note can carry a monthly escrow amount. When a payment arrives, you enter how much of it was for escrow, and OwnerNote posts that part to the note's escrow ledger and the rest to the loan, so the balance, interest and payoff stay exactly as they would without escrow. You record each tax bill, insurance premium or HOA payment as you pay it. The note page shows the escrow balance, warns when it is short, and compares the last year of bills with twelve monthly amounts so you can see when the amount needs to go up.
Escrow shows on the buyer's receipts, reminders, statements and payment coupons, and the year-end interest statement includes property tax paid from escrow. OwnerNote never holds the money: you keep it in your own account, and OwnerNote keeps the record.