Many homebuyers, particularly first-timers, often question the need for mortgage-related escrow accounts. “Why can’t I pay the charges myself?” they wonder.
There are good reasons, for both you and your lender. But first, a quick explanation of escrow accounts.
Sometimes known as impound accounts, escrow accounts are set up by your lender to pay certain property-related expenses: real estate taxes, homeowner’s insurance, mortgage insurance and sometimes your community association fees.
The money for these payments is collected by your lender (or the company that services your loan) every month, along with the principal and interest you owe on your mortgage. And when those payments are due, the lender disburses them to the proper payee.
Most lenders require escrow accounts to make sure these bills are paid on time, thereby reducing the risk that you will default on the mortgage or incur liens on the property. Either of those possibilities will place a cloud on your title, making the property more difficult to sell -- by you or the bank, should it have to foreclose.
While there is no law, either federal or state, that requires lenders to impose escrow accounts, it is probably a good idea for borrowers to go along. Otherwise, you’d have to come up with large payments once or twice a year to cover these charges. How large? In 2017, the average property tax on a single-family home was $3,399, according to ATTOM Data Solutions -- and that’s just one expense.
Years ago, when banks paid substantially higher rates than they do now, it might have made sense to keep control of your money rather than cede it to your lender. But not now, with banks paying next to nothing.
Without an escrow account, you run the risk of being late on payments for taxes and insurance, or missing payments altogether. If you fail to pay your property taxes, your state or local government may impose fines and penalties or place a tax lien on your home. You could also face foreclosure. And if you fail to pay your taxes or insurance, your lender may add those amounts to your loan balance, add an escrow account to your loan, purchase insurance for you and bill you for it. (And lender-purchased insurance, known as force-placed insurance, is typically more expensive than buying your own policy.)
Indeed, it makes good sense to “budget” for these costs by paying them with 12 monthly installments to your lender.
Again, there is no law requiring escrow accounts. But there is a federal law, the Truth in Lending Act, that protects borrowers by strictly controlling how lenders handle their escrow accounts.
For one thing, the lender is not allowed to collect an excess amount. And there are limits on the amount a lender may require you to put into your account.
Over the course of a year, starting on the anniversary date of your mortgage, you will be required to pay into your account no more than one-twelfth of the total of all payments for all escrowed items.
After the first year, you will be required to make up any difference in the amount owed and the amount collected: There’s almost always a shortfall in the first year, because your payments are usually based on estimates as opposed to actual bills. Lenders will either ask for a lump-sum payment or allow you to catch up with an acceptable increase in your monthly escrow payment over the upcoming calendar year.
In addition, the lender may require a cushion, not to exceed an amount equal to one-sixth of the total needed for the year, to make sure there is never a shortage again.
Lenders are also required to perform an annual escrow account analysis and notify you of any deficit or surplus in your account. If there is a shortage, you can be required to correct it. If there is a surplus of more than $50, the lender must ask if you’d like it returned or applied to the next year’s escrow amount.
If you have a fixed-rate mortgage, your payment for principal and interest will never change, month to month. But because the other fees collected for your escrow account can change, and often do, your total house payment is likely to change with them.
In some jurisdictions, once you have paid down the balance of your mortgage to a certain percentage of the original loan amount, you have the right to terminate your escrow account. In Illinois, for example, 65 percent is the benchmark -- as long as you are current with your payments.
But why would you? After all, escrow accounts are usually the easiest way to handle these recurring payments.
Finally, if you have questions about or issues with your escrow account, call the company administering your account. Follow up in writing if necessary. By law, the servicer must acknowledge your question or complaint in writing within 20 business days of receipt, and must resolve the issue within 60 business days (or state the reason for its position). Until the complaint is resolved, however, you should continue making the required payment.
If you’re not satisfied, and your servicer is registered in your state, escalate your complaint to the agency in your state that regulates the mortgage business. If your servicer is a national or out-of-state institution, contact the federal Consumer Financial Protection Bureau at 855-411-2372 or consumerfinance.gov.