A mortgage escrow account ensures that homeowners do not miss important tax and insurance payments. Most mortgage lenders prefer borrowers to have an escrow account for this purpose. If you as a borrower decide to waive the account, be aware that many lenders will charge additional fees in doing so or may insist on an escrow account as a condition for loan approval.
Escrow Account Basics
An escrow account is commonly set up by a lender to hold money from a homeowner that will be used to pay taxes and insurance. This type of account needs to be established in writing and is subject to certain conditions. Escrow accounts are also used by brokers of real estate to hold money at the time of a real estate closing. An escrow account is similar to a savings account in that any money that is deposited into the account is saved for a specific purpose.
When an escrow account is set up with a mortgage, it is an amount beyond the principal and interest of the mortgage. Depending on the mortgage company you chose, many require a homeowner to maintain an account to pay for their property taxes and hazard insurance. Many FHA loans require an escrow account for the entire term of the loan.
In almost all cases, deposits are made on a monthly basis with the mortgage loan payment. Payments accrue at the bank or lending institution. The lender then becomes responsible for paying the borrower's insurance premiums and property taxes on or prior to the due date.
The amount that needs to be placed in the account initially and on a monthly basis is determined by the cost of insurance and a tax assessment of your property. This amount tends to fluctuate each year as premiums rise and further assessments are completed.
Escrow accounts may be required of borrowers who have less than 20 percent to put down on a home purchase. The account acts as a type of "insurance" for lenders who may be at risk of not recouping their money if a house is seized due to non-payment of taxes or if it is damaged or destroyed by a fire, natural disaster, or other problem. This is why most lenders prefer the borrower to have an escrow account in place.
If your lender requires that you have this type of account at the time you take out your loan, know that it can sometimes be eliminated once you have paid down the principal of the loan to the point where you have at least 20 percent equity in the property. However, it may be beneficial to keep the account for the entire term so that you don't have to worry about insurance and property tax payments as separate bills. Some lenders will charge additional fees if the borrower opts out of an escrow account and decides to pay their taxes and insurance out of pocket.
Escrow accounts are regulated by the federal government through the Real Estate Settlement Procedures Act (RESPA). RESPA guidelines require escrow payments to be recalculated on a yearly basis to account for any increases in insurance and taxes. If there is an excess of $50 or more in the escrow account, it must be returned to the borrower.
RESPA protects you as a borrower in the following ways:
- Does not require lenders to impose escrow accounts on borrowers
- Prohibits lenders from charging excessive amounts for the account during the term of the loan
During the process of buying or selling a home, there are several items that are held in escrow. These include:
- Title to the home
- Buyer's earnest money
- Money set aside for repairs
These items are held in escrow until specific conditions are met and transfer of the property ownership occurs.
Consider Your Specific Needs
An escrow account can simplify the process for first-time homeowners that will be paying insurance and taxes along with their mortgage payments. It guarantees that payments will not be missed and can help the borrower avoid financial problems. Escrow accounts also make it easier on the budget since you will be paying a portion of the taxes and insurance on a monthly basis rather than in one lump sum. However, if you do not want your monthly mortgage payment to potentially fluctuate annually, an escrow account may not be for you. It is always best to talk to your lender to find out what will work best for your specific needs and situation.