At closing, you will be required to deposit real estate taxes and insurance premiums into an escrow account (sometimes called an impound account). An escrow account ensures that the taxes and insurance will be paid, and on time. This protects the lender from tax liens and uninsured losses that the borrower can't repay.
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 annually.
How escrow accounts are managed
The amount in the escrow account varies during the year due to tax assessments and insurance premium adjustments. The lender typically will cover any shortfalls until it can adjust your monthly payment to make up for tax hikes and premium increases. Your monthly mortgage payment will fluctuate from year to year, even on long-term fixed-rate loans.
Can I avoid escrow?
Yes. Some lenders 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 the lender boosts your interest rate to compensate for the additional risk it is assuming.
Once an escrow requirement is in place, it can be difficult to persuade 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 servicer.