Mortgage escrow accounts were developed more than fifty years ago when many Americans started losing their homes to foreclosures, mostly 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.
Mortgage escrow accounts are made to protect the homeowner by making sure that all insurance premiums and property taxes are paid in a timely manner. Escrow guarantees that there will always be enough money available to pay these bills on time. This way, the homeowner can avoid overdue taxes and insurance.
The U.S. Department of Urban Development (HUD) has administered the Real Estate Settlement Procedure 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.
Although borrowers are not required to maintain an escrow account with their lender, the lender may require it of the borrower. Escrows are made to protect the lender and as well as the borrower. Borrowers who do not understand the purpose of the escrow account, or those who have questions or other concerns, should consult with their lenders right away. It’s important for the borrower to understand escrow completely in order to be aware of all the benefits.
Escrows reassure homeowners that their mortgage related bills will be paid on time by automatically budgeting the borrowers insurance and tax obligations over a years time. This way homeowners can rest assured that their obligations are taken care of without having the burden of coming up with several large, lump sums of cash each year. In addition, it’s comforting that homeowners don’t have to calculate any 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 not enough 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 if the money has been collected by the homeowner at that time. 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 have made it possible for mortgages to lower their rates and have lower down payments while protecting the interests of the investors. This has made the home mortgages more attractive as a secure investment, allowing escrow to lead the way to a stronger home mortgage market. Escrow accounts also prove beneficial to local governments by saving them money by 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 take on the responsibility of managing that borrower’s escrow account. The new lender may review the borrower’s escrow account to be certain that the funds are being collected sufficiently enough 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 that is often called a cushion, in their escrow account to cover potential increases in the borrowers insurance and tax bills. Many lenders may ask that the borrowers fund their cushion to the maximum amount 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 for an explanation. If the borrower is not satisfied with the explanation, then they may file a complaint with HUD.