Escrow resembles a savings plan set up to accumulate money to pay annual real estate taxes and property insurance when those bills come due. The lender or mortgage holder sets up escrow accounts and collects one-twelfth of the estimated annual tax and insurance fees each month. Escrow balances and monthly charges are adjusted to reflect the actual bills when they are paid. A buyer can usually waive escrow accounts and pay taxes and insurance directly, but there may be penalties, and a buyer should examine all factors before making a decision.
Escrow accounts are set up for the life of the mortgage, usually from 15 to 30 years, and the fees are added to the lender's monthly bill for principal and interest. Escrow funds may be held by the lender in a specified account or transferred to a third party to hold for payment when taxes and insurance are due. Waiving escrow requires the buyer to provide the lender with proof of payment of taxes and insurance each year. Buyers also must pay any special insurance, like earthquake or flood coverage.
No Escrow Interest
Escrowed funds typically do not earn interest while they are held, while a buyer who waives escrow can retain that money and invest it. The buyer, however, must be prepared to pay taxes and insurance fees in a lump sum each year. Some states and many insurers offer partial payment options so bills can be paid, usually quarterly, to reduce the amount needed at any one time.
Most lenders charge a fee for waiving escrow. This is a onetime charge, collected when the loan is closed and added to the closing costs. Waiver fees can be substantial, up to about one-quarter point of interest. A lender may refuse to waive escrow on some loans, such as those where the buyer has less than 20 percent equity, or require a buyer to make an additional down payment.
Figure Your Loan Fees
Do the math on your specific loan. Figure the annual tax and insurance fees and decide how much interest or money could be earned with a certificate of deposit, stock fund or other investment; balance that against a waiver fee. On a $300,000 mortgage with $5,000 in annual taxes and insurance, a waiver fee might be $750. Earning 5 percent on that $5,000 investment would produce $250 a year or equal the waiver fee in three years.
Consider that conditions change over time. Taxes and insurance rates vary year by year as do interest rates and investment returns. A lender will refund excess escrow amounts or reduce the monthly charge to reflect the larger balance, but also will add charges and change fees to make up deficits. Most individual and small business savings today will not earn 5 percent; some other investments may, although without guarantees.
- Department of Housing and Urban Development: FAQs About Escrow Accounts for Consumers
- Collins Development Co.: How Does Escrow Work?
- Fannie Mae: Homebuying Process
- Bankrate.com: Know Escrow Rules Before Waiving Them
- Wealth With Mortgage: What Does It Mean To Escrow Taxes And Insurance?
- Daily Interest: Escrows
- Lending Tips.com: What is an Escrow Waiver?
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