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
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.
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.