Question: My wife and I have just signed a contract to purchase a nice house in this area, and we have been shopping around for mortgage money. We are considering putting down 20 percent of the purchase price, and obtaining a loan for the balance. All of the lenders we have approached have assured us that we will not have to pay private mortgage insurance, but these same lenders are requiring that we escrow money for taxes and insurance. Is this really necessary and why do lenders require these escrows?
Answer: Lenders make a lot of money when they collect funds on a monthly basis to pay your future real estate taxes and insurance. In most cases, lenders do not pay interest on these escrowed funds. And, to add insult to injury, most lenders will charge the borrower a one-time "set up" fee -- ranging from $60-75 -- to establish this escrow arrangement. This fee must be paid at settlement.
The word "escrow" means to put something -- such as a deed or money -- in the custody of a third party until certain conditions are met. In the mortgage arena, if you buy with 20 percent or less down in most cases, the lender collects on a monthly basis one-twelfth of the annual real estate tax bill and the annual hazard insurance premium. When the tax or insurance bill comes due, the lender uses those escrowed funds to make the required payment.
Over the years, I have received many questions dealing regarding escrow. Here is a brief summary showing how lenders often handle escrow funds in my community, however -- because state laws differ -- you should consult an attorney to determine what your local law permits.
The theory behind the escrow makes sense. Lenders are concerned that if you do not pay your annual real estate taxes or if you do not pay your annual insurance premium, the lender's security will be affected.
Unfortunately, while the theory makes sense, in my opinion the primary reason for wanting these escrow accounts is that lenders accumulate huge sums of money which they can use for their own benefit, without paying interest to the consumer.
Many years ago, the Congress of the United States adopted the Real Estate Settlement Procedures Act (RESPA), which includes the regulation of these escrow accounts. Because of major consumer objections and concerns, Congress in 1990, amended the Act and also imposed strict reporting requirements on lenders.
It should be pointed out that this law applies to all "federally related mortgage loans." This is a very broad category, and includes loans secured by a first lien -- deed of trust or mortgage -- on residential real property including condominiums and cooperatives, and is either insured or guaranteed by a governmental agency such as the Federal Housing Administration or the Veterans Administration .
It also applies to loans intended to be sold by the originating lender to such secondary mortgage markets as the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac).
Under the law -- unless local law requires otherwise -- at the initial settlement, a lender has the right to require a borrower to deposit into an escrow account for property taxes and insurance, a sum not to exceed the amount of these actual charges, plus one-sixth of the estimated total amount of these taxes or insurance premiums.
If the taxes come due in January, for example, and you are settling in July, your first month's payment will not be due until September 1st. For the months of September, October, November and December you will make four months escrow payments. Since the lender will require a full year's payment in January, and at that time only four months payments will be in escrow, it has the right to escrow eight months at settlement, plus one-sixth of the total amount -- which amounts to an additional two months' worth of escrow. Thus, at settlement, do not be surprised if the lender requires you to pay a full ten months tax payments into escrow. These funds are to be held by the lender and paid when the taxes come due.
These same rules apply on a continuing yearly basis until you pay off your loan. In other words, the lender has the right to hold two additional months escrow, on the theory that if you are delinquent in one or two of your monthly payments, the lender will still have sufficient funds by tapping into this two months' surplus.
On an annual basis, the lender who services your loan must send you a statement clearly itemizing "the amount of the borrower's current monthly payment, the portion of the monthly payment being placed in the escrow account, the total amount paid into the escrow account during the period, the total amount paid out of the escrow account during the period for taxes, insurance premiums ... (as separately identified) and the balance in the escrow account at the conclusion of the period."
This statement must be submitted to each borrower not less than once a year.
Once you receive the annual statement, you must review it carefully. Confirm with your taxing authority and with your insurance company exactly when the payment is due, and the amount of that payment. Sit down with a calculator and determine whether the lender has properly calculated the amount of the escrow.
Congressional testimony has uncovered many errors made by mortgage lenders, some in favor of the borrower and others in favor of the lender.
Additionally, I have seen far too many cases where lenders inadvertently do not make the required real estate tax payment on time -- or at all. Often, the first time that the homeowner learns of this non-payment is when they receive a notice of tax sale from the jurisdiction where their property is located.
Accordingly, it is strongly suggested that every homeowner who is required to escrow for taxes and insurance write their lender -- once a year -- demanding proof of payment of their real estate tax and insurance premium. If the lender does not respond promptly, contact your appropriate tax authority to confirm payment of these taxes, and also complain about the lack of response to your state or local financial regulatory authority.
Escrow for taxes is, unfortunately, a way of life in the mortgage industry. However, as a consumer-borrower, you have the right to review, analyze and complain should you find that your escrowed funds are not being handled properly. After all, escrowed funds belong to you until they are paid to the taxing authority or the insurance company.