Understanding How An Escrow Account Works and If You Should Avoid Them

by Hank Coleman

home_for_saleAn escrow account is established by a broker, under the provisions of law, to hold funds on behalf of two or more people until a contract or transaction has been completed.  People are most familiar with escrow accounts in conjunction with their mortgage.  A person’s mortgage lender sets up an escrow account to receive monthly payments from the home buyer which is usually lumped into the mortgage payment and used to pay for obligations such as homeowners’ insurance, property taxes, and assessments.

A friend of mine recently asked me about escrow accounts and whether or not we really need them.  He really got me thinking, and I thought that I would share a little background on them with you all.  In the county where I live in the South, our homes’ values have recently been reassessed, and we have received notices of our property values changing.  This coincided with escrow account statements and the like that I also received from my mortgage holder, prompting a few questions around the neighborhood and the good old water cooler.

How Most Escrow Accounts Work.  Usually, your mortgage company collects and directs that a portion of your mortgage payment go into a separate escrow account.  The mortgage company / escrow company makes a payment on your behalf to your insurance company and county or state tax accessor when those bills are due.  Funds accumulate in your account every month and are used to pay for the bills when they come due.  For example, approximately $100 out of my own mortgage payment is set aside in an escrow account every month for the payment of my yearly property tax bill which is due in October. 

Do You Really Need Escrow Accounts?  No.  Not necessarily.  You technically could pay your insurance premiums and tax bill yourself if you are responsible and disciplined enough.  That’s what most people who own their homes outright have to do.  But, escrow accounts are great to have.  Escrow accounts keep you safe…safe from missing an important payment and safe incase you do not receive the high value things you buy.

Most Lenders Require Escrow Accounts Anyway.  Lenders usually require borrowers to include their property taxes and insurance premiums in their monthly mortgage payments and be placed in escrow to ensure the safety of the bank’s loan and investment.  For example, if the taxes on your home are not paid, your county’s tax authority could place a lien on your home which could have a higher priority than the bank’s own lien.  If you went into foreclosure, that would just be even more money that the bank would lose right off the bat since they would be paid out of the sale proceeds after the county got their tax money.  Also, if the house burns down or is flooded, the lender’s protection goes with it if the insurance premiums had not been paid.  Requiring an escrow account keeps the bank protected.

Good and Bad Points of Escrow.  When the lender takes care of two of your biggest payments, that is taking a huge weight and responsibility off of your shoulders.  On the other hand, you provide the bank or escrow company free use of your money for eleven months or so out of the year.  It is similar to the interest free loan we give the federal government when we receive a huge income tax refund every year.  You will never see a dime of any interest they happen to make off of your money while it is in their possession.  Maybe control freaks may still want to try and avoid escrow.  There have even been a few cases of mortgage lenders messing up your insurance or tax payments costing more in late fees and penalties.

Ways To Avoid Escrow

  • Put 20% or more down as a down payment when you buy the house
  • Negotiate for it like you would the interest rate or paying points

Escrow is best known in the United States in the context of real estate transactions where a homeowner’s mortgage company establishes an escrow account to pay property tax and insurance as part of the terms of the mortgage. Escrow companies are also commonly used in the transfer high value property such as websites, cars, and businesses.  Understanding the reasons and benefits of these accounts will help you stay on the right side of the law and protect you and your high value assets from theft or fraud.

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{ 1 comment… read it below or add one }

mj June 8, 2014 at 2:45 pm

If your servicer is (or might become) Chase, don’t do it. They’ve twice now decided to just up and not pay my homeowner’s insurance, even though there’s more than enough in my escrow. Last time they then billed me for their own 3x more expensive insurance. It took two months of headaches to get it fixed last time. Just discovered it today again. I wish I could go back and decide not to get an escrow account!

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