Mortgage escrow accounts have been in the news lately and seem to be greatly misunderstood by many consumers. The original idea behind mortgage escrow accounts was to protect the interests of homeowners and they have been serving that purpose for more than 50 years.
Mortgage escrow accounts came into being more than 50 years ago. In the 1930's, many Americans were losing their homes in foreclosures because of late tax payments. To help ease the burden on homeowners who had to come up with large, lump sum payments at tax time, lenders agreed to take on the responsibility by collecting smaller monthly sums from homeowners along with their mortgage payment. In 1934, the government mandated that lenders manage escrows on all FHA insured mortgages. This then became the standard practice for all mortgages.
Mortgage escrow accounts ensure that homeowners' property taxes, fire and hazard insurance premiums, mortgage insurance premiums and other escrow items are paid in a timely fashion. They are a guarantee that there is always enough money to pay these bills when they are due so that the homeowner avoids the risk of lapsed insurance coverage or delinquent taxes.
Escrowing is governed by the Real Estate Settlement Procedures Act of 1974 (RESPA), administered by the U.S. Department of Housing and Urban Development (HUD). Lenders must manage their escrow accounts in compliance with this federal law and with the interpretations set out by HUD.
In addition, the 1990 Housing Bill recently signed into law by the President, requires lenders to issue itemized statements of escrow accounts to borrowers on an annual basis. While many lenders are already providing homeowners with regular statements of their escrow accounts, the new law should ensure that every lender follows this practice.
Escrowing as practiced by the nation's lenders protects both the borrower and the lender. Borrowers who have questions or concerns about their escrow accounts should talk to their lenders immediately. Consumers who know the purpose of escrows and are aware of the benefits they provide are the best insurance against misunderstandings between borrowers and lenders or misleading information from any source.
The most obvious advantage of escrows is that they automatically budget the borrower's tax and insurance responsibilities over the course of a year. Homeowners do not have to worry about coming up with several large, lump sum payments, each with different due dates, throughout the year. If there is ever a fire in the home, or if the basement floods causing damage, the homeowner is assured that the home is protected by up-to-date insurance.
Because of escrows, homeowners also do not need to worry about calculating unexpected increases in their taxes or insurance premiums. It is the responsibility of the lender to allow for possible increases in these payments.
Even when there are not enough funds in a mortgage escrow account to meet increased tax or insurance payments, the lender typically covers the bill without charging interest to the borrower. It is very common for lenders to pay taxes and insurance premiums when they are due even though all the money for these bills has not yet been collected from the homeowner. It is estimated that in 1989 alone, lenders advanced more than $600 million to homeowners who then avoided the penalties and risks of not paying their taxes and insurance on time.
Escrows protect the interests of investors in home mortgage loans. By making home mortgages more attractive and secure as investments, escrowing has led to a healthier mortgage market. As a result, loans with better terms and lower down payments are available to homebuyers.
Escrow accounts also benefit local governments by providing a more efficient, less expensive means of tax collection. Rather than working with millions of homeowners, municipalities need only collect from a few hundred lenders.
The law is very specific in setting limits on the amount that the lender may collect. the lender may require a monthly payment of 1/12 of the total amount of estimated taxes, insurance premiums and other charges reasonably anticipated to be paid. Plus, the lender may collect an additional balance of not more than 1/6 of the estimated annual payments. If the lender determines there will be or is a deficiency in the escrow accounts, the law permits the lender to require additional monthly deposits to avoid or eliminate the deficiency.
When the servicing of your loan transferred to another lender, the new lender takes on the responsibility of managing your escrow account. At that time, the new lender may examine your escrow account to make sure that the funds being collected are sufficient to cover all payments that are to be made. If the new lender feels that the amount collected must be adjusted, you will be notified of the change in your monthly payment. For more information, contact the Mortgage Bankers Association of America, Consumer Affairs Division, 1125 15th Street, N.W., Washington, D.C. 2000