Curve

Mortgage closing: Why does my lender want so much escrow money?

Peter Miller
The Mortgage Reports contributor

In this article:

What is escrow, and why does it cost so much?

  • An escrow account is established by the lender at closing and funded with money from the borrower. The lender then uses the money to pay costs like property taxes, homeowner’s insurance, flood insurance, and more.
  • The escrow account often must be “front-loaded” at closing, to give the lender a little cushion to make sure the money will always be there when needed.
  • Under federal rules, a lender can collect enough escrow funds to cover your annual bills, plus two monthly payments, plus $50.

Mortgage closing: How much money do you need?

A mortgage closing is like a high school graduation. After much work and preparation, the big day arrives, everyone is excited, and when the ceremony is over, more than a few questions remain.

Some of the most common questions from a closing often concern that strange thing known as “escrow.” What is it — and why does it cost so much?

Verify your new rate (Nov 20th, 2018)

What is an escrow or impound account?

In basic terms, an escrow account is established by the lender at closing and funded with money from the borrower.

The lender uses the money to pay such costs as property taxes, homeowner’s insurance, flood insurance and sometimes homeowner association dues.

Often, you must “front-load” the account at closing, meaning you’ll initially put in more than strictly needed to pay what’s owed. This gives the lender a little cushion — to make sure the money will always be there when needed.

Why do lenders require escrows or impounds?

The idea behind an escrow fund is to protect both the borrower and the lender.

Everyone knows that a home can be foreclosed if the mortgage is not paid. However, a home can also be foreclosed for other reasons, such as not paying property taxes.

With an escrow account, the lender has the money in hand to pay such costs on your behalf.

The escrow account can also benefit you. Because once established, the account balance is maintained by regular monthly contributions from you, added to your mortgage payment.

This helps you budget for large costs, which are otherwise assessed annually or semi-annually.

How do escrow accounts work?

Escrow accounts hold money collected in advance from you. When property taxes or insurance premiums are due, the lender pays those for you.

Let’s say that your property taxes are $4,000 a year, and homeowners insurance is an additional $1,200. That’s a total of $5,200. To maintain the escrow account, the lender will collect 1/12 of the bill each month, a total of $433.33.

How much can lenders keep in escrow accounts?

Under federal rules, a lender can collect enough escrow funds to cover your annual bills, plus two monthly payments, plus $50.

In the example above, the lender could have in escrow as much as $5,200 (the expected size of the bills), plus $887 (an amount equal to two monthly escrow payments), and $50. This is a total of $6,137.

Reconciliation

Once a year, the lender provides an escrow account statement to you. It must also refund excess money collected.

If the escrow balance is insufficient to cover your costs (perhaps your taxes or insurance premiums have increased), the lender can require you to make up any shortage.

Usually you get to choose between paying a lump sum, or making up the shortage during the next year by paying a higher monthly escrow fee.

Mortgage closing and escrow

If you buy a home with 20 percent or more down, the lender may waive the requirement to have an escrow account. The lender might require you to put your loan on an auto pay or impose a fee (.25 points is common) to waive escrows.

This means you’d pay your own property taxes, homeowners insurance, and other fees as they become due.

So a borrower with a big down payment can avoid monthly escrow payments. However, the obligation to pay taxes and insurance remains.

Many borrowers who make big down payments still want an escrow account, because it’s an easy way to budget costs and assure that basic bills are paid.

Risking foreclosure and other problems

What happens if you don’t have an escrow account and fail to pay taxes or homeowners insurance?

In the case of taxes, you can face foreclosure. The county could take your property from you. If you don’t pay for property insurance, the lender will probably purchase a replacement policy for its own protection.

This coverage is called  “force-placed insurance,” and it’s not a good thing. Because the lender is picking the replacement insurance, it does not have an obligation to select the cheapest or best coverage.

Force-placed insurance can be very expensive, in some cases two-to-ten times the cost of typical policies.

How can you avoid force-placed insurance? Get an escrow account.

What are today’s mortgage rates?

Current mortgage rates can be affected by the presence or absence of escrows or impounds. Some lenders allow you to waive impounds, but may charge you higher fees or offer a slightly higher interest rate.

If you want lenders to waive escrows, tell them upfront when shopping for a mortgage so they can give you an accurate mortgage quote.

Verify your new rate (Nov 20th, 2018)