Mortgage escrow accounts are designed to hold funds for property taxes, mortgage insurance, and homeowners’ insurance, but they usually don’t earn interest under federal law.
The U.S. Department of Housing and Urban Development (HUD) doesn’t require these accounts to be interest-bearing, though some states mandate it. While they don’t function like savings accounts, escrow accounts help homeowners manage and budget essential housing expenses more efficiently.
Key Takeaways
- Mortgage escrow accounts do not typically earn interest, as banks are not required to pay interest on them.
- Some states mandate interest payments on escrow accounts, but conditions or exceptions may apply.
- Mortgage escrow accounts are used to collect monthly payments for property taxes, mortgage insurance, and sometimes homeowners’ insurance.
- Federal regulations generally prohibit paying interest on escrow accounts, but state laws vary on this issue.
- Homebuyers often establish escrow accounts for earnest money or as part of closing costs.
What Is a Mortgage Escrow Account?
Escrow is a temporary condition of an item, such as money or property, that has been transferred to a third party with the intention of delivery to a grantee as part of a binding agreement. Money or property in escrow is generally delivered by an escrow agent to a grantee upon satisfaction of outlined terms. Lawyers most commonly will act as escrow agents and work with a bank or financial institution to be escrow custodian.
While property is held in escrow, the buyer cannot take possession of or occupy the space. Real estate deals must clear a series of stages during the escrow process. An appraisal of the property must be conducted if it has not already been done. There may be issues with the transaction if the appraised value of the property is lower than the agreed-upon purchase price.
When buying a home, mortgage escrow accounts are typically established by the mortgage lender. During the buying process, the account holds the earnest money or initial down payment that the buyer is putting toward the home. After the closing, homeowners frequently use escrow accounts to spread out property tax, mortgage insurance, and sometimes homeowners insurance payments. The funds are deducted from your total monthly mortgage payments, placed in the escrow account, and paid out on your behalf by the loan servicer.
Legislative Attempts at Escrow Interest Reform
There were attempts to pass legislation in 1991 and 1993 regarding the payment of interest on escrow bank accounts. Both of these proposals failed to pass, and there have not been any further attempts to change the escrow system, at least on the federal level.
State-Specific Regulations on Escrow Account Interest
There are some exceptions on the state level. The states that do, in fact, require interest payments on escrow accounts are:
- Alaska
- California
- Connecticut
- Iowa
- Maine
- Maryland
- Massachusetts
- Minnesota
- New Hampshire
- New York
- Oregon
- Rhode Island
- Utah
- Vermont
- Wisconsin
Practical Implications of Escrow Interest Requirements
Many of these states require that any interest earned through an escrow account be paid to the customer. However, even in these states, there might be legal exceptions that preclude banks from paying interest.
Evaluating Escrow Accounts As Investment Options
Even if they are earning interest, escrow accounts aren’t an acceptable alternative to standard savings accounts for two key reasons. First, HUD caps the total excess sum that you can deposit in an escrow account at one-sixth of the total sum required to be placed and paid out over the year. Second, the Consumer Financial Protection Bureau’s Regulation X dictates that, at the end of each year, account custodians are supposed to refund any surplus funds of $50 or more to the borrower within 30 days.
These limitations severely restrict any compounding interest on escrow account balances that customers might typically enjoy in a regular certificate of deposit (CD) or savings account.
Due to this fact, customers who manage their personal finances closely might actually benefit by investing the money that they pay into an escrow bank account in other investment vehicles. For those whose credit and loans are already highly leveraged, it might be easiest to make smaller monthly payments rather than one large annual payment. Since mortgage escrows are designed to protect lenders from defaults, the bank ultimately makes the final decision on whether it will require a borrower to establish an escrow banking account.
When Do You Establish an Escrow Account?
An escrow account might be set up during the home-selling process as a repository for the buyer’s down payment or good faith money. Otherwise, it is set up during the closing, and the funds deposited into it are considered part of the closing costs.
How Much Goes Into an Escrow Account?
Typically, when an escrow account is set up, buyers put in two months’ worth of estimated property taxes, mortgage insurance payments (if any), and (sometimes) homeowners insurance premiums. Although these payments are made monthly, lenders often like to have a cushion in the account in case of unexpected increases. After that, the escrow account is funded with a month’s worth of payments for each bill.
What Exactly Does an Escrow Account Cover?
The money in your escrow account goes to pay these bills:
- Property taxes
- Mortgage insurance
- Homeowners insurance
- Other sorts of specialized coverage, like flood insurance, if required
Escrow accounts don’t cover one-off government assessments or special taxes, homeowners association dues (even if membership is required), or supplemental home insurance policy premiums.
Are Escrow Accounts Required?
An escrow account is required if you bought your residence with a Federal Housing Administration (FHA) loan or through certain other government lending programs. If you have a private mortgage, then it depends on the lender. However, an escrow account might be required if you made a downpayment of less than 20%.
What’s the Advantage of an Escrow Account?
A mortgage escrow account can be a good budgeting tool. It ensures that your property taxes and mortgage insurance premiums will be paid on time and in the proper amounts. By putting money toward these bills each month, you avoid a big expense each quarter or year. And there’s the convenience of everything being figured into your monthly mortgage payment and often being paid directly out of the escrow account.
The Bottom Line
Lenders set up mortgage escrow accounts to hold funds for property taxes, homeowners’ insurance, and mortgage insurance, helping ensure these bills are paid on time. Borrowers make monthly deposits into the account, which makes budgeting easier and reduces risk for lenders. While federal law doesn’t require banks to pay interest on escrow balances, some states do mandate it.
