Mortgage Closing: Why Does My Lender Want So Much Money In Escrow?

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Mortgage Closing: How Much Money Do You Need for “Escrow”?

One of the biggest costs you will encounter when closing a home is the “escrow account”.

You are probably not very keen on contributing to this fund, especially since you have no idea what it is for.

While it may seem like an unnecessary burden, escrow is really just a way to prepay the costs associated with owning a home.

Let’s dive a little deeper.

Check your eligibility to buy a home with the best lenders here. (July 2, 2021)

In this article:

What is escrow and why is it so expensive?

  • An escrow account is established by the lender at closing with the home buyer’s funds. The lender ultimately uses the money to pay for costs like property taxes, home insurance, flood insurance, etc.
  • The escrow account often needs to be “loaded up front” at closing, to give the lender a little cushion to ensure that the money will always be there when needed.
  • Under federal rules, a lender can collect enough escrow funds to cover your annual bills, plus two monthly payments, plus $ 50.

Why do lenders require escrow or impoundment?

The idea behind an escrow fund is to protect both the borrower and the lender.

Everyone knows that a house can be foreclosed if the mortgage is not paid. However, a home can also be foreclosed for other reasons, such as non-payment of property taxes.

With a escrow account, the lender has the cash on hand to pay these charges on your behalf. This is one way to ensure that you won’t be behind on your property tax payments.

You can also benefit from the escrow account. Because once established, the account balance is maintained by regular monthly contributions from you, added to your mortgage payment.

If you didn’t have an escrow account, you will likely have to pay the county hundreds or thousands of dollars several times a year. It’s hard to budget.

The same goes for home insurance. Your insurance agent only requires payment once a year. It can be a large sum. If you haven’t budgeted for it, your insurance coverage will expire and you won’t be compensated if your home is damaged or destroyed.

How do escrow accounts work?

Escrow accounts hold the money collected in advance. When property taxes or insurance premiums are due, the lender pays them “for you”.

Of course, the lender does not bring the money. They simply make the payment from the funds they have already collected from the escrow account.

Let’s say your property requires the following annual payments.

  • Taxes: $ 4,000 per year
  • Home insurance: $ 1,200 per year
  • Total: $ 5,200
  • Monthly amount received by the lender: $ 433

To maintain the escrow account, the lender will collect 1/12 of the annual bill each month. So if your principal and interest payment on the mortgage is $ 1,500, your total mortgage payment to the lender would be $ 1,933 per month.

How much can lenders keep in escrow accounts?

Under federal rules, a lender can collect enough escrow funds to cover your annual bills, plus two monthly payments, plus $ 50.

In the example above, the lender could hold up to $ 5,200 (the expected amount of the bills), plus $ 887 (an amount equal to two monthly escrow payments) and $ 50. This is a total of $ 6,137.

Annual reconciliation of the escrow account

Once a year, the lender provides you with an escrow account statement. He must also reimburse the excess money collected.

If the escrow balance is insufficient to cover your costs (perhaps your taxes or insurance premiums have increased), the lender may ask you to make up any shortfall.

Usually, you have the choice of paying a lump sum or filling the gap over the next year by paying a higher monthly escrow fee.

Mortgage closing and escrow

If you buy a home with a down payment of 20% or more, the lender may waive the requirement to have an escrow account. The lender may ask you to put your loan on an automatic repayment or charge a fee (usually 0.25% of the loan amount) for waiving the escrow.

It means you would pay yours property taxes, home insurance and other charges as they become due.

Thus, a borrower with a large down payment can avoid monthly escrow payments. However, the obligation to pay taxes and insurance remains.

Many borrowers who make large down payments still want an escrow account because it’s an easy way to budget for costs and ensure basic bill payments. Plus, the lender doesn’t charge a monthly fee or “scum” to make payments for you. One hundred percent of the money you put into the escrow account must be used for your taxes, insurance, or other charges that you would pay anyway.

Risk foreclosure and other issues

What if you don’t have an escrow account and don’t pay your taxes or home insurance?

In the case of taxes, you can facing foreclosure. The county could take your property away from you. If you don’t pay for property insurance, the lender will likely purchase a replacement policy for their own protection.

Compulsory insurance can be very expensive, in some cases two to ten times the cost of typical policies.

This coverage is called “compulsory insurance”, and that is not a good thing. Since the lender chooses replacement insurance, they are under no obligation to select the cheapest or best coverage.

Compulsory insurance can be very expensive, in some cases two to ten times the cost of typical policies.

How to avoid compulsory insurance? Get an escrow account.

How do I apply to buy a house?

An escrow account has nothing to worry about. The upfront cost seems daunting, but you only pay the costs up front.

Having said that, you want to keep the overall upfront costs low. The best way to do this is to research the best lenders.

Shop the best lenders today for better rates and lower fees. (July 2, 2021)

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