Advantages and Disadvantages of Mortgage Escrows

 December 4, 2000, Revised December 3, 2002, November 16, 2004, November 2008

"I can set up an escrow account for paying taxes and insurance, or not. The decision is mine. How do I make it?"

The major advantage of a mortgage escrow is that the lender assumes responsibility for paying your property taxes and homeowners insurance. This is also the major disadvantage. In addition, with an escrow the lender gets to keep the interest on your account.

Mortgage Escrow Responsibility

With an escrow, the borrower adds a fixed amount every month to the mortgage payment. The additional payment required is calculated by the lender, though the borrower can do it as well, as explained in How Do I Figure Escrows. This additional payment goes into the borrower's escrow account. The money in this account belongs to the borrower, though the lender usually keeps the interest on it, as explained below.

The lender is responsible for paying taxes and insurance out of the account. For many borrowers, this is a convenience. For "control freaks", it is an infringement on their personal autonomy.

In support of being a control freak, occasionally lenders muck it up. Their systems fail and the payments don't get made. I have heard about a number of such cases from borrowers, some of them real horror stories.

I doubt that this happens very often, and the lenders responsible will make the borrowers whole, but they don't compensate them for their time, pain and suffering. It would be extremely difficult if not impossible for a borrower to assess the risk of such an occurrence with any specific lender.

Loss of Interest Earnings

When you establish an escrow account with the lender, in most states the lender gets to keep the interest earnings on the account. To calculate the interest loss, multiply the escrow account balance every month times 1/12 of the interest rate that you would receive if the account was yours rather than the lender’s. For example, if the account balance for December is $2,000 and your bank pays 6% on your account, your interest loss for December is $10: 2,000 times .06 divided by 12. Sum the monthly figures to get the annual loss.

A few states require that lenders pay interest on escrow balances. If you are in one of them, subtract the rate you would receive on the escrow account from the rate you would earn on your own account. For example, if lenders must pay 4%, your loss in the example would be only 2%, amounting to $3.33.

To find the monthly escrow account balances, do two passes through the steps listed in How Do I Figure Escrows. The first pass gives you the account balances assuming no initial deposit at the time of closing. The second pass will give you the balances corrected for the required initial deposit.

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