escrow account

escrow account

(1) A separate bank account for keeping money that is the property of others. Attorneys and real estate agents are required to keep escrow accounts for client money and not commingle client money with their own funds.(2) An accounting entry by a mortgage lender showing the amount on hand from the borrower's monthly budget loan payments to pay real estate taxes and insurance when those bills become due.

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Escrow Account

In a home mortgage transaction, a deposit account maintained by the lender and funded by the borrower, from which the lender makes tax and insurance payments for the borrower as they come due.

Lenders generally require escrow accounts. The rationale is that it prevents a weakening in the protection provided to the lender by the property. If the taxes are not paid, the tax authority could place a lien on the property that would have a higher priority than the lender's lien. Similarly, if the house burns down or is flooded, the lender's protection goes with it if the insurance premiums had not been paid.

Size of the Account: To assure themselves that there will always be enough money in the account, lenders ask for more than they actually need as a “cushion.” In years past, many of them maintained unreasonably large cushions. To deal with that, the Department of Housing and Urban Development (HUD) issued a ruling that placed a ceiling on the size of escrow accounts, which in turn limited the amount the lender could ask the borrower to deposit at closing.

The rule is that the deposit cannot exceed the amount needed to prevent the balance from falling below an amount equal to two-
months worth of tax and insurance payments at its lowest point during the year. While HUD does not do a lot of enforcing, my impression is that all but a handful of lenders follow the HUD rules. If you want to check the calculation, I explain how to do it on my Web site, see “How Do I Figure Escrows?”

Reasons for Avoiding Escrows: The least important reason borrowers may want to avoid escrow is to capture the interest earnings on the account for themselves. The amounts involved are small. I explain how to measure the interest earnings on my Web site in “Should I Escrow?”

The more important reason is to establish control over the payments. Lenders require escrow to assure that the payments will be
made, and borrowers may want to avoid escrow for the same reason. Lenders occasionally screw up, and when this happens it can be a nightmare for the borrower. See Servicing/Recourse Against Bad Servicing.

Ways to Avoid Escrow: Most lenders will waive escrow requirements if the borrower makes a down payment of 20% or more. The logic of this waiver is that if the borrower has that much equity in the house, it is safe for the lender to rely upon the borrower's self-interest to pay the taxes and insurance premiums.

So, if you intend to put down 20% or more, let the loan officer know up front that you will not be escrowing.

If you intend to put down less than 20%, it becomes more complicated. In most states, lenders are willing to waive escrows for a fee—usually 1/4 to 3/8 of a point. However, in Washington, D.C., Illinois, New York, and Oregon lenders are barred from charging a waiver fee, which means that they may be less willing to waive escrows in those states.

If you are already escrowing, getting rid of it is not easy. You must convince the lender that it is in his interest to eliminate the requirement in your case.

If the lender is a depository institution servicing its own mortgages, your best shot is to appeal as a customer of the firm. If it isn't
too costly, depositories usually want to satisfy their customers or potential customers. Increasingly, however, loans are being serviced not by lenders but by servicing agents working for lenders.

Servicing agents make most of their money from servicing fees paid by lenders and from the interest earnings on escrow accounts. When a loan they are servicing is refinanced, however, the income on this loan ceases unless the agent is the one making the new loan. If the servicing agent understands that if you cannot terminate your escrow account, you intend to refinance your mortgage with another lender (not with him or her), you will get his or her attention. After all, it is better to lose only the escrow interest than to lose both the escrow interest and the servicing fee.