Escrow. It’s a weird word. And most people don’t know what it means.
According to Investopedia:
An escrow is a financial instrument held by a third party on behalf of the other two parties in a transaction. The funds are held by the escrow service until it receives the appropriate written or oral instructions or until obligations have been fulfilled. Securities, funds and other assets can be held in escrow.
If you have a mortgage, you may also have an escrow account along with it where you pay 1/12th of your insurance and property tax every month and when the bills come due, the mortgage company pays the bill from that account. One thing’s for sure, it makes those bills much less painful.
But you can also apply this concept to your own bills. What bills do you have that you pay annually or biannually? Car insurance, membership fees, subscriptions, maybe you buy a pool pass at the beginning of every summer, etc. Expenses that you know are coming but maybe only happen once or twice a year. Why not try to save a bit each month so that when the bill comes due, you’re ready for it?
Now, this has obvious benefits with bigger bills like car insurance. Let’s say your car insurance is $600 every six months. When that bill comes due, will you have an extra $600 in your budget just magically waiting for you? Without budgeting, I sure wouldn’t. But if you set aside $100 a month, when that bill arrives, you’ll be ready to pay it.
But what about smaller bills? Say you have a membership fee that is $50 a year. $50 is still a lot of money, but maybe you can move things around in your budget so it doesn’t break the bank that month. If you saved monthly, however, you might not feel the pain at all. Setting aside $4.17 a month is pretty simple.
The question is how to do this. I use YNAB, and their new cloud based app has a “goals” setting. If I have a $50 bill coming in December, I can tell the app that my goal is to have $50 in that account by December, and it will tell me how much money I need to save every month to get to $50. If I save too little one month or put a bit extra into the budget category, the app will redo the calculations for me.
But if you’re not a fan of YNAB, you can certainly do it on your own. If you just want to escrow for one bill, like your car insurance, but you’re worried that you might accidentally spend that money, I recommend opening up another savings account and transferring money into it every month. You can even set this up as an automatic transaction so you don’t have to think about it.
You can also sit down and say “Okay, what are all of my annual and biannual bills?” Add up the total, divide by 12, and that’s how you figure out what you need to save every month. Of course, this isn’t quite accurate, since all those bills aren’t coming due in 12 months, but it’s a start. The best way would be to figure out what you need to save each month based on when each bill is due. It seems daunting, I know, but if you sit down with a piece of paper, a pencil, and maybe a calculator, you’ll figure it out in no time at all.
We’ve all had those days where we’re going along, budgeting, feeling good about keeping the spending under control and then an annual bill shows up and blows everything to smithereens. Self-Escrow. It’s a great way to prepare for those larger expenses with the least amount of pain possible.
Megan is a 40-something government employee in the Washington, DC area. She got interested in Personal Finance when she got out of college and realized that her paycheck wasn’t going to go as far as she had hoped. Since starting this blog, she has managed to buy a house and make a solid start on her retirement goals, and hopes to help others do the same. Here is her story:
In 2007, I was a gainfully employed 20-something with no debt but not a lot of knowledge about personal finance. It was a co-worker’s comment about Roth IRAs that sent me to the internet, searching for information. It was then that I realized that I really didn’t know a whole lot about personal finance and that my current financial situation was due a lot to inherent frugal tendencies, generous family members, a fear of debt, and good luck. While that was working for me, clearly I needed a better plan.
While I had no debt, I was also pretty much living paycheck to paycheck and not worrying about going over budget (I say this as if I had a real budget) because I had an emergency fund set aside to cover any overages.
Except that’s not what an emergency fund is for.
So I did a lot of research, read a lot of blogs, and decided that I needed a plan. I needed to budget. I needed to know what I was spending my money on. I needed to prepare for the future.
I decided to create a blog not only to make myself accountable to others but also to share the knowledge that I gained along the way. I’ve learned so much from my fellow bloggers, and I hope that my readers can find something useful in what I have to share as well.
Self-escrow is a great way to earn a bit of extra interest off of your money if you are diligent enough to track those large incoming bills as you mentioned. Just a bit of discipline can really pay off!
Money Beagle says
Yep, we totally do this. I have categories from heating & electric bills to auto repairs to saving for household repairs. My spreadsheet is pretty cumbersome but it makes it worth it to know that money that we need is where it belongs!
Wealth Kept Blog says
An Escrow Account is a saving account where you deposit money for paying off your home insurance and taxes. The account is opened by the lender who loans you money for the mortgage. Once you have paid a percentage of the mortgage amount, and have not defaulted in the payment, then the lender might decide to excuse you from any further payments through the Escrow Account.