If your house burns down and you aren't insured, your lender won't be happy. Lenders collect mortgage escrow to prevent that from happening and protect their investment in your property. Part of your monthly mortgage payment goes toward homeowners insurance and property taxes. Your lender collects one-twelfth the estimated cost of the bills in each monthly mortgage payment and holds the money in an escrow account until the bills come due. The lender then pays on your behalf.
Most first time home buyers pay into a mortgage escrow account unless they put a large down payment on a house. Either way, if you don't like keeping track of bills, escrow is the way to go. Your lender pays your homeowners insurance and taxes when the due dates roll around. You don't have to remember to pay or to budget for one large annual payment. If the lender ever fails to send in the check, the obligation is on your lender to fix the problem.
The federal Real Estate Settlement Procedures Act lays down the law where escrow is concerned. One RESPA rule that protects you is the limit on how big a cushion lenders can require you to place in the account. A cushion is the amount over the estimated annual expenses. The largest cushion your lender can hold for you is the amount of two months of escrow payments. RESPA doesn't require your lender to pay you the interest on the funds in your escrow account, although some states require it.
If your insurer increases your premiums or you switch to a different, cheaper policy, you'll see it reflected in your monthly mortgage payments. Your lender reevaluates escrow once a year and adjusts your required escrow payments to reflect the changed costs. If you want to get rid of escrow completely, you have to build up significant equity -- a value above the mortgage -- first.
Force Place Insurance
If you don't use an escrow account and subsequently fall behind on your insurance payments, the company servicing your loan has the right to force-place you with a new policy after your old one lapses. This is bad news, as force-place policies usually cost more than the original policy. Some servicers with financial ties to insurers force-place you with more interest in their financial well-being than yours.
- Mortgage-X: FAQs About Escrow Accounts
- Mortgage Professor: Advantages and Disadvantages of Mortgage Escrow
- National Consumer Law Center: The Consumer Financial Protection Bureau Should Rein in Mortgage Servicers’ Use of Force-Placed Insurance
- Bankrate: Let Your Escrow Grow for You, Not Your Lender
- Chicago Tribune: Force-Placed Insurance, an Unnecessary Burden for Strapped Mortgage Borrowers
- Insure.com: Force Place Insurance: High Cost Home Insurance Policies Under the Microscope
A graduate of Oberlin College, Fraser Sherman began writing in 1981. Since then he's researched and written newspaper and magazine stories on city government, court cases, business, real estate and finance, the uses of new technologies and film history. Sherman has worked for more than a decade as a newspaper reporter, and his magazine articles have been published in "Newsweek," "Air & Space," "Backpacker" and "Boys' Life." Sherman is also the author of three film reference books, with a fourth currently under way.