A deposit account funded by a borrower which a lender uses to pay for tax and insurance expenses in a mortgage transaction.
This is not to be confused with the account an escrow company uses to hold the funds for a property transaction until all parties satisfy conditions of a deal.
Lenders require escrow accounts to protect themselves from their two worst fears.
Firstly, protection from the IRS placing a lien on the property in front of the lender’s lien due to unpaid taxes.
Secondly, to ensure that insurance premiums are being met so that there will be an insurance payout should the house damaged and condemned.
From the above information, it should be clear that a lender has a vested interest in keeping the escrow account as loaded as possible.
In fact, in the past lenders are known to require borrowers to deposit more money in the account than realistically necessary.
However, regulations were then written to put a limit on these types of accounts.
The ruling was that money in escrow accounts should not have to exceed two months worth of insurance premiums and tax calculations.
Are escrow accounts really necessary?
The answer you would get from lenders is an absolute yes.
However, sometimes borrowers can feel insulted for being treated like young children without financial discipline.
Other than feeling a little victimized by such lender demands, a borrower would also be forgoing the potential interest that can be earned from the money deposited in these accounts.
These are real opportunity costs!
And who is to say that all will be handled efficiently as long as there is an active escrow account as the real life cases where servicing agents fail to pay for property taxes and insurance.
Who will be responsible for the liability should an adverse event happen and insurance was not paid even though the account had more than enough money to make those payments?
However, no matter which side you cut, if a lender wants such an account set up, they will almost certainly get their way.
Avoiding escrow accounts
You can leave it to a bank to find every opportunity or reason to charge their customers.
With the rise in home buyers desiring to avoid escrow, many lenders now allow waivers on escrows for a fee.
But some states ban such forms of waivers. Meaning there would be no incentive for lenders in those states to waive escrows.
Nevertheless, most lenders will be willing to waive their escrow requirements should a borrower make a down payment of 20% or more.
The logic behind this is that when there is more equity at stake, a homeowner would be more accountable for meeting tax and insurance requirements.
If you can prevent these account from opened in the first place, count yourself lucky as those who already have escrow accounts will find a different set of challenges in closing the account.
Servicing agents are slowly and surely making their presence felt in the real estate industry.
These are companies hired by lenders to that administer loans from the moment of disbursement to the time of full repayment.
What areas of servicing they do includes:
- Collating account statements
- Tracking late payments
- Calling up borrowers who are delinquent
- Maintaining transaction records
- Pay for taxes and insurance
Because their existence and profitability heavily depends on accounts being kept, they will undoubtedly do whatever is in their power to refuse closing the accounts.
Yet if you are left with no other option, refinancing the mortgage will mean that the escrow account will simply have to be closed.
This threat is often enough to motivate them to find alternative solutions to solve your issues with the account.