Escrows

Escrow funds are deposited with the bank on a monthly basis and the bank pays your Property Taxes and Home Insurance. The purpose of these funds is for the bank to guarantee that their investment is protected.

Advantages of having an Escrow Fund:

Disadvantages of having an Escrow Fund:

The Escrow Account
The federal Real Estate Settlement Procedures Act limits the amount of cushion in these accounts to a maximum of two months of escrow payments.

Escrow accounts generally include:

1. Homeowners' insurance
   
   
2. Property taxes. (The lender will pay your tax and insurance bills from the escrowed money.)
   
   
3. Private mortgage insurance. If your down payment was less than 20 percent of the sale price, you probably are required to pay PMI. At closing, the standard is that three months of PMI payments are collected. In some cases, PMI is paid annually, or in a lump sum at closing. Interim interest, or daily rate of interest.

The escrow accounts ensure there always is money available to pay taxes and insurance premiums on time. Your monthly mortgage payment will include 1/12th of the total tax and insurance bills on your home for that year, so that the escrow accounts are replenished.

Lenders typically cover shortages when payments increase until your billing has been adjusted to the new rates. Shortages will occur when your taxes are raised (yes, every year!) or your Homeowner's Insurance increases.

Do I have to have the Cushion?
This is a common question that I hear from borrowers and the answer is yes, you have no choice. Understand that taxes go up, not down, in most cases and this cushion will make sure that there is enough in the fund to pay any increases in taxes.

As for the cushion on the insurance, there is no great answer for that since insurance policies on homes don't generally change as drastically as taxes. It's just the way it is, I wish I had a better answer for that one.

The only answer to not having a cushion is to waive escrows and pay the bills yourself.

How to Avoid Escrows
When you have at least 20% equity in your home, you have the option of having the bank waive your escrow fund and you get to pay these bills on your own.

Generally, the bank will charge you 1/4% of the loan amount for you to have this option. This fee is known as an Escrow Waiver Fee.


About Escrow Waiver Fees
I have heard quite a few complaints from borrowers through the years about this escrow waiver fee. For those borrowers, while it seems that if you can pay these taxes on your own, there is definitely some risk that the bank is taking by putting such a large investment on the line by trusting you to pay them on time.

It may seem that the bank is just finding a way to charge you for "one more thing" but try to put yourself in their shoes. If you loaned someone thousands of dollars and the one way that you could lose your investment is if taxes were not paid or if there was an accident and the insurance was not current, would you really want to trust another person to pay those bills to protect your investment or would you want to pay them yourself?

Unless you are borrowing less than 50% of the value of the home, the bank still owns the majority of your home.

On another note, some lenders will not charge this escrow waiver fee (I have covered this fee myself at times) but I can guarantee that you have paid this fee in one way or another, whether it is in the rate or as an increased cost somewhere else.

There is an example with numbers of how quickly you will recover the excrow waiver fee in the article
Should you waive escrows?

Summary
Whether or not to have an escrow fund is a decision you need to make on your own when you have 20% equity in your home.

Some borrowers would rather be responsible for their own bills rather than to trust the bank to pay these bills for them. If this is you, pay them on your own.

Some borrowers receive much of their income in lump sums and are in better financial position to pay these bills at one time versus having a higher payment throughout the year.

Should you be a borrower who receives a regular salary or paycheck, the decision is really a wash since you really need to put the money away every month to be able to pay these bills when they become due.

If you are not good at saving throughout the year, do not consider waiving those escrows. It will only make it more painful when those taxes come due.

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