An escrow is a legal arrangement with a neutral third party where money or goods are deposited until a contract is legally satisfied. In layman’s terms, that means an escrow service is basically a middleman between a buyer and a seller, or in the case of a mortgage, a middleman between a homeowner and the county (for property taxes), insurance companies, and anyone else who the homeowner designates to pay with funds from the escrow account.
Mortgage escrow accounts are very popular for mortgages and in many cases mandatory. Mortgage escrow services first became popular as a means to decrease the number of foreclosures due to people not paying property taxes. The problem was that people were not always prepared to pay a large annual property tax payment.
How an escrow service works
A mortgage escrow service is much like a forced savings account. Money is paid directly to the escrow service where it is held until payments are due. For example, when you pay your mortgage bill, several hundred dollars per month are added to your payment. That money doesn’t go toward your interest payments or principle. This money is set aside in your escrow account and used to pay your annual or biannual property taxes, insurance, and other bills.
Advantages and disadvantages of a mortgage escrow service
The biggest advantage of using an escrow service is not having to come up with large payments once a year to pay your bills. It is much easier for most people to pay $200 per month into a forced savings account instead of paying $2400 at once. Mortgage escrow accounts also guarantee your bills are paid on-time. Your payments have already been budgeted for you and the money is waiting and available in your account. When the bill is due, the escrow account takes care of everything for you. It is nice not to have to remember payment dates, amounts, etc.
There are advantages to the lender and county as well. The lender is assured your insurance premiums will always be up to date, so their asset (your house) is protected in the event of destruction. The county is assured they receive their property tax payments on time.
There are disadvantages though – most escrow accounts do not earn the account holder interest, though some earn interest at a low rate. For someone with a large house and a $10,000 property tax bill, that adds up to a lot of lost opportunity every year. There are also associated fees which cut into your bottom line.
Can you avoid using an escrow service?
Yes, but not always. Some mortgages require escrow accounts, especially for first time home buyers or home buyers with small down payments. There are some advantages for going without an escrow service – your money can earn you interest and you may be eligible for early payment discounts for some bills. But the disadvantages are obvious – you are required to pay your tax bills and insurance payments on time or risk losing your house.
A mortgage escrow account is an easy and simple way to manage your annual tax and insurance payments and put them on autopilot. Sure, it costs a little extra money every month, but to me, it is well worth the convenience.
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{ 16 comments… read them below or add one }
My mortgage broker told me that it is illegal for escrow companies to earn interest on your money in escrow. I was surprised to hear that, but he swears it’s true.
Also, I was able to avoid escrow on my own home, but I had to pay a several hundred dollar fee at closing in order to waive escrow.
I’m about to purchase a rental property though, and they won’t let me waive escrow (despite a 20% downpayment, good reserves, etc). I’ve been told you pretty much always have to do escrow with investment properties.
My escrow account for my mortage is interest bearing. It isn’t a huge interest rate, and I could do better with my bank’s savings account, but it satisfied the lender that there was one and it satisfied the escrow company because they got to hold the money.
Just ask at closing when you buy a house or refinance if (a) escrow is necessary if you think you can budget and save, and (b) what the interest rate is. A mortgage broker wants your business and can easily make it interest bearing.
We’ll probably do an escrow account. It just seems like such a handy way to manage it. Also, I doubt we’ll ever have a big house with the big property taxes.
Meg, I could be wrong on escrow accounts earning interest for the escrow company. I just assumed that if it was there it was being used that way. I will have to double check and make a correction if that is the case. Thanks for the insight!
Blaine, thanks for the comment. My wife bought this house before we got married and she did everything. The next time we buy a house I will keep that in mind. Some interest is better than no interest!
Mrs. Micah, I like having an escrow account. I realize I am losing out on some interest, but the convenience is nice. I prefer low maintenance! :)Thanks for the comments!
Just a note - I updated the article due to Meg’s and Blaine’s comments. I know the escrow companies make money on fees, but I assumed they make money from earning interest as well. I couldn’t find proof either way, so I removed the statement. Thanks!
After 13 years, we just cancelled our home escrow account. The lender charged us a $250 “processing fee”, but by automatically depositing money monthly in an ING account to cover the expenses ourselves, the interest will cover the fee in less than two years, and after that, we’ll earn the interest for ourselves.
Sami, That sounds like a decent deal. Well, not the $250 “processing fee,” I guess the lenders will always find a way to get their money. But in the long run, it seems like you will make out. Congrats!
We are immigrant first time home buyers from the Philippines.What is an ING account and can we do this at the beginning of the loan or only after a number of years?thank you!
Hi Pam,
ING is an on-line bank account that is well known for having some of the highest interest rates for savings accounts, great customer service, and a user-friendly interface.
The ING account was mentioned because some people prefer to handle their own payments instead of using an escrow account because it allows them to earn interest on their money instead of it sitting in escrow for several months.
My insurance dropped my house without my knowledge due to an error by the insurance agent. I Found out when my mortgage company tacked the escrow on to provide insurance for the home without letting me even try to find another insurance company. the last 3 months the insurance company has taken my entire payment and applied it to the escrow account making me default on the loan. now I’m 2500 dollars behind with just enough income to pay the monthly payments and they are still threatening to default. Is that even legal?
Ken: have no idea if it is legal, but it certainly doesn’t sound ethical. I recommend contacting your mortgage lender and explaining the situation. If that doesn’t work, you should contact an attorney who specializes in real estate or contact your state’s Attorney General office. Best of luck to you!
our yearly bill is around 2500 for tax’s and insurance but the escrow amount is all ready over 7000 our home payment went up over 600 dollars a month so the bank can use our money for whatever they choose, tried to get this straighten out for months but the accounts are handled in india. and before you think this is some fly by night mortgage company, its actually citi mortage, and we have never been late on any payments we pay 5 days before its even do, so is it really legal that they can set the payment each month on whatever they choose, because this was not what we payed the first 2 years and we have had this mortage for 5 years?
Kimberly, It depends on the terms of your mortgage. If you have a set rate mortgage, then your payments shouldn’t change very much. If you have an adjustable rate mortgage you may find that your rates can change.
Read the terms of your mortgage very closely and find out what your mortgage states. That should give you the information you need. If you have trouble understanding the mortgage terms, contact your mortgage company for clarification. Don’t hang up the phone until you understand why your rates have increased.
Hello, I have a question regarding the escrow account. If I get a mortgage with escrow and I overpay, meaning if the escrow payment each month added up to more than my taxes and insurance and anything else. What happens to the extra money? Thanks
Don, the money will be returned to you or credited against future payments. You may have to request it, but some escrow accounts will either send you a check at the end of the period, or they may leave the money in your account and lower your payments for the following year. Call you escrow account to determine how they handle overpayments.
OK, thanks a lot for the reply. That what I thought but wasn’t 100 % sure.