Many renters are familiar with escrow accounts. If a landlord requires a security deposit and the last month's rent prior to moving in, the funds must be kept in escrow until the tenant moves from the property. Mortgage escrow accounts are different; they are often required by home mortgage lenders.
Purpose and reasons for an escrow account
Mortgage escrow accounts are used to pay property taxes and homeowner's insurance premiums. Lenders require these accounts to ensure the property is insured (protecting their interests) and to ensure the property is not foreclosed on because of non-payment of property taxes. With the exception of Veteran's Administration loans, most purchase loans where a borrower has put down less than 20 percent are subject to escrow accounts.
Funding mortgage escrow accounts
When a homeowner first purchases a home, lenders will require an escrow payment. The initial payment into the escrow account will typically include the amount necessary to pay the first quarter's insurance and taxes. When a homeowner pays their monthly mortgage payment, the lender will have calculated the amount to be paid monthly to fund the escrow account. At the end of each quarter, the lender then remits the payments to the proper parties.
Under- and over-funding escrow accounts
Because property taxes and insurance payments can fluctuate it is possible to have discrepancies in what is owed and what is available in escrow. Most lenders will give a homeowner an option to pay any shortage over a period of time. In other cases, the lender may request an additional lump sum payment to make up any shortfall. In the case of over-funding (too much money in the account) the lender may send the homeowner a check for the overage. It is important to note that in most cases, a lender will require the borrower to have the equivalent of two months' insurance and taxes in escrow at all times.
Benefits of escrow accounts
The most significant benefit of an escrow account is not having to worry about making separate payments for insurance and taxes. When a lender requires the borrower to have these accounts (commonly called impound accounts), the lender makes the required payments for taxes and insurance. This is particularly helpful for borrowers who have trouble saving money. Escrow accounts also help ensure taxes and insurance are paid on time, avoiding penalties and late charges.
Criticism of escrow accounts
Homeowners who are opposed to escrow accounts believe they should have control over their funds rather than turning them over to their mortgage lender. While this may be true, it is important to remember most borrowers will not earn enough interest to make it worthwhile to open a separate account for their insurance and tax payments.
Can escrow accounts be discontinued?
Once a homeowner has 20 percent equity built up in their home, lenders may be willing to waive escrow requirements. In some cases, refinancing a home can eliminate escrow accounts as well. It is important to note that any loan which is insured by the Federal Housing Administration (FHA) will always require the borrower to have an escrow account.
Lenders are required by law to provide a homeowner with an annual escrow account statement. This statement must show a record of all deposits and disbursements. Lenders are not required to pay interest on escrow payments; however, should a lender fail to pay a property tax bill or insurance bill on time, they are responsible for any late fees or interest charges accrued as a result of late payment.