In theory, escrow accounts make sense for everyone involved.  Borrowers can be completely vigilant about making their mortgage payments but for one reason or anther they sometimes forget about putting money aside for property taxes and homeowners insurance.  This is a big deal, because even if mortgage payments are all up to date a late property tax payment can be cause for the beginnings of foreclosure proceedings.  Property taxes can also have a way of sneaking up on people, since they are traditionally due only once or twice a year.  If a homeowner doesn’t budget for the tax payments and they don’t have an escrow account through their lender then this can be problematic when the bill arrives.

To solve this problem, lenders came up with the idea of escrow accounts.  When a borrower makes a mortgage payment they are paying for four different things: principal (the money still owed on the loan), interest, taxes, and insurance.  Some folks don’t realize this, and they assume that the money they send each month is steadily decreasing the amount they owe on their mortgage loan.  Although it is true that money is applied to the principal each month, the amount of payment that actually goes towards lowering the principal balance is actually quite small in the beginning but steadily increases as the principal balance lowers.  The majority of the money in a mortgage payment goes towards the interest.  Some of the money goes towards escrow accounts to, and the amount depends on what sort of property taxes and insurance the borrower has.

Property taxes vary from county to county.  Some states, such as California and Florida, have notoriously high property taxes while other states can boast lower property taxes.  Homeowners insurance also varies depending on location of the home, the cost of the home, and several other factors.  Flood insurance is generally not escrowed, and is paid in one lump sum annually.

Some lenders offer the option for borrowers to pay their property taxes and homeowners insurance on their own.  It isn’t the homeowners insurance, which makes the lenders nervous, as it is the property insurance, which is generally higher and therefore more difficult to scrape together if the bill comes and the money has not been put aside by the borrower.  Some lenders will charge borrowers extra money in order to avoid escrow, and some lenders offer small interest bearing accounts for escrow in order to allow the borrowers to make some money off the funds which are just sitting there.  The interest rates are generally low and not comparable to current market rates, but the fact that the accounts are interest bearing is enough to make some borrowers feel better about the whole process.

For borrowers who feel anxious that their lender will forget to pay the property taxes or homeowners insurance, fear not.  Lenders who require escrow accounts are legally bound to make these payments on time, and if for one reason or another the payments are not prompt and correct then it is the lender, not the borrower, who is liable.  Because of this, many borrowers actually prefer to have escrow accounts because it makes it easier to make all the payments on time, without having to budget for property taxes and insurance in addition to the mortgage payment. 

Borrowers who have escrow accounts can relax knowing their affairs are all in order, and if these borrowers also have automatic payments coming out of their bank accounts or paychecks then they have the easiest mortgage payment system available. They don’t even need to think about paying their mortgage or taxes or insurance, because it all comes out without them having to do anything.  Escrow accounts are not inherently bad, after all, and can actually be very beneficial to borrowers who would otherwise need to worry about budgeting for taxes and insurance in addition to a mortgage payment.

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