Escrow Escrow; Then and Now

mortgage escrow accounts

Mortgage Escrow Accounts were developed more than fifty years ago when many Americans started losing their homes to foreclosures, mainly due to late tax payments. Homeowners were burdened to come up with large, lump sums of money at tax time that was often too difficult to pay.

To ease the burden, lenders agreed to collect the taxes in small monthly payments made along with the mortgage payment. In 1934, this became standard procedure when the government stepped in and made it mandatory that lenders manage escrow accounts on all Federal Housing Administration (FHA) mortgages. The following is more about them.

The value of mortgage escrow accounts

Mortgage escrow accounts are made to protect the homeowner by ensuring that all insurance premiums and property taxes are paid on time. Escrow guarantees that there will always be enough money to pay these bills on time. This way, the homeowner can avoid overdue taxes and insurance.

The U.S. Department of Housing and Urban Development (HUD) has administered the Real Estate Settlement Procedures Act (RESPA) to regulate all escrows and include laws for all lenders to follow when managing and funding the borrower's escrow account.

All lenders must maintain their escrow accounts and comply with federal law, with the interpretations set by HUD. Lenders are required to release itemized statements of escrow accounts to all borrowers yearly. While most lenders already issue these statements, the 1990 Housing Bill will ensure this practice.

Escrows are made to protect the lender as well as the borrower

Although borrowers are not required to maintain an escrow account with their lender, the lender may require it of the borrower. Borrowers who need help understanding the purpose of the escrow account, or those who have questions or other concerns, should immediately consult with their lenders. The borrower needs to understand escrow entirely to know all the benefits.

Escrows reassure homeowners that their mortgage-related bills will be paid on time by automatically budgeting the borrower's insurance and tax obligations over a year. These are calculated at real estate closings. This way, homeowners can rest assured that their responsibilities are taken care of without having the burden of coming up with several large lump sums of cash each year.

Homeowners don't have to calculate unexpected increases in their insurance premiums or taxes

It is the lender's responsibility to allow any potential increases in the payments, therefore covering the bill without charge to the borrower if there are insufficient funds in the mortgage escrow to pay the increased bill.

Many lenders will pay for the insurance and taxes when the payments are due, regardless of whether the homeowner has collected the money. In 1989, lenders advanced an estimated $600 million to homeowners to avoid penalties and any risk of not paying their insurance and taxes on time.

Escrow accounts make it possible for lenders to lower their rates

and have lower down payments while protecting the interests of the investors. This has made home mortgages more attractive as a secure investment, allowing escrow to lead the way to a more substantial home mortgage market.

Escrow accounts also benefit local governments by saving them money using a less expensive and more efficient way of collecting taxes. Municipalities will only need to collect from a few hundred lenders instead of millions of homeowners.

For borrowers who decide to refinance or transfer their loan to another lender, the new lender will manage that borrower's escrow account. The new lender may review the borrower's escrow account to ensure that the funds are collected sufficiently to cover all payments. Should the collected amount need readjustment, the new lender will notify the borrower of the change in monthly payments. Lenders in some states may pay interest on the money held in an escrow account, although the RESPA does not require it.

Some lenders may ask borrowers to keep an excess balance

often called a cushion, in their escrow account to cover potential increases in the borrower's insurance and tax bills. Many lenders may ask that the borrowers fund their cushion to the maximum of one-sixth of the total amount paid each year.

If, for some reason, a lender asks the borrower to keep more than one-sixth in the escrow cushion; the borrower has the right to an explanation. If the borrower is unsatisfied with the explanation, they may file a complaint with HUD.

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