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Escrow accounts protect the lender against . . . you


At closing, you will be required to prepay real estate taxes and insurance premiums into an escrow account (sometimes called an impound account).

Money held in escrow helps protect lenders from borrowers who fail to pay real estate taxes and insurance premiums. Such negligence could result in a lien on the property by local tax authorities or leave the lender without collateral in the event the house was destroyed by a natural disaster after the homeowners insurance policy had lapsed.

Escrow accounts enable the lender to pay your homeowners insurance and property taxes on your behalf, as well as interim interest (from the day of closing to the end of the month) and private mortgage insurance, if any. Some lenders charge a fee of $50 to $150 to set up an escrow account.

The federal Real Estate Settlement Act limits the amount lenders can require in escrow to a maximum of two months payments. Escrow assessments and adjustments are generally made on an annual basis.

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How escrow accounts are managed
Practically speaking, the actual amount of money in your escrow account varies during the year due to tax assessments, rate hikes and insurance premium adjustments. Your lender typically will cover any shortfalls, at least until they can adjust your annual escrow payment or bump your payment to replenish your account. As a result, your monthly mortgage payment will fluctuate from year to year, even on long-term, fixed-rate loans.

Many home buyers prefer the convenience of the escrow account. It allows them to spread their property taxes and insurance expenses over a 12-month period without writing checks every month. Others object to losing interest income; not all states require lenders to pay interest on monies held in escrow.

Can I avoid escrow?
Can you avoid escrow altogether? Yes. Some lenders may allow you to pay your own property taxes and home insurance premiums, especially if your loan-to-value ratio is below 80 percent. But don't be surprised if they also boost your interest rate to compensate for the additional risk they're assuming.

Once an escrow requirement is in place, it can be difficult to convince a lender to cancel it. If your loan is sold, as is common, and there is nothing in the lending agreement that provides for cancellation of the escrow requirement, you'll have to live with the decision of your new mortgage company.

-- Posted: March 15, 2004
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