To Escrow or Not to Escrow

By Richard Pisnoy

There’s a lot of confusion about why lenders require escrow for taxes and insurance. So here’s a simple way of thinking about it.

An escrow account is an account a mortgage lender uses to pay the taxes and homeowners insurance for your property. Most lenders require a tax escrow when homeowners are borrowing more than 80% of the value of their home (80% Loan to Value or LTV).

While most people believe the first mortgage on a property supersedes all other claims in the event of foreclosure, that’s not true. The distinction for first-in-line to be paid goes to the city and school taxes. Think of them as the first lien holders on your property. They get paid first should a lender need to foreclose on a property.

So escrowing is a way for lenders to minimize their risk of losing all or partial collateral on their loans. In the event a homeowner falls behind on the tax payments, the lender knows the taxes are covered and the borrower, not the lender, is wholly responsible.

Don’t let escrow scare you. It can be a true friend to borrowers. Here’s how:

Escrow eliminates payment shock. When the tax bill comes, it can be quite large. If you’re not escrowing, that tax payment as well as the insurance payment can be a little menacing. When you escrow, your payments are broken down into a monthly payment. You never see the big hit.

Escrow is a convenience factor.  As a borrower you no longer have to worry about writing the check for your tax bill or insurance bill. The lender does that for you. Obviously, you should always confirm that those payments have been made.

Escrow is another set of eyes. Your payments can and will change with every tax or insurance increase or decrease. Your lender automatically analyzes tax and insurance fees once per year to ascertain a escrow shortage or overage. Even though they’re watching it as another set of eyes, you can and should request your lender do an escrow analysis at any time to prevent this from happening.

No fees or interest for escrow. Many people are under the impression that the escrow account is an interest bearing account. This is not the case with most lenders. As a borrower you can, of course, put money in an interest bearing account with another institution and pay the taxes and insurance on your own.

It’s also important for you to know that it’s possible to cancel an escrow account and pay the taxes and insurance directly. This depends on the lender and their terms for the cancellation of the escrow account, but this option would only be available on a conventional loan.