In 2018, United Wholesale Mortgage (UWM) decided it would offer an option to people who applied for mortgages backed by Freddie Mac or Fannie Mae. The borrowers could have escrow-free loans, at no extra charge. Even if their down payments were low. Even if they had so-so credit.
Other industry professionals criticized the move. Wasn’t UWM allowing unnecessary risk by relying on these borrowers to take care of their own tax and insurance payments? Only a decade earlier, the industry was gripped by a foreclosure crisis, in part because lenders had issued risky loans without escrow accounts. But UWM did not consider that argument relevant. The company wanted to give its customers options.
Who was right? Should escrow be optional? If it is, should you take it or leave it? Let’s explore.
Why Mortgages Have Escrow Accounts
The typical borrower pays the mortgage company a set amount each month. This covers the principal and interest — and escrow. What part of a borrower’s payment goes into the escrow account? The answer is whatever is needed to cover annual taxes and insurance, divided into monthly periods.
So, the mortgage servicer draws from the escrow account when bills are due for local property taxes and the homeowner’s (or condo owner’s) insurance policy. The mortgage servicer also uses escrow funds to pay the private mortgage insurance premiums, if the borrower has to make them.
Why doesn’t the mortgage lender just let the homeowner deal with these responsibilities?
Lenders want to reduce the risk that a borrower will let something fall through the cracks. If the borrower has to pay the insurance and property tax bills, they might wait or forget about these bills up to the last minute. And then they’ll have to scrape up all this money from somewhere.
Overdue taxes lead to liens on the home. In extreme cases, unpaid taxes lead to foreclosure. A lack of homeowner’s insurance could mean exposure to expensive repair costs after a pipe bursts, and so forth.
The simple fact? A borrower’s home is the lender’s collateral. The lender wants its value protected. That’s why most lenders are fans of escrow.
Why Some Borrowers Want to Pay Their Own Bills
Some borrowers prefer to pay their bills by themselves. Why’s that? There are at least four different reasons a borrower might have:
- Some borrowers don’t want the mortgage servicer micromanaging their bills. They want to manage them directly. People whose incomes or financial goals vary from month to month might be especially motivated to pay tax and insurance costs in their own time.
- Borrowers might prefer to keep those funds in an interest-bearing account until the bills are actually due. Why, they might ask, would I want to pay in advance for the mortgage servicer to hold the funds (in most states, without having to pay any interest) until the bills come due?
- Borrowers who pay the bills with a credit card might get reward points. In contrast, the usual escrow practice is to receive deposits straight from the borrower’s bank account. Granted, the borrower might have to pay fees for using a card. But…
- Borrowers could aim to pay property taxes early. Avoiding escrow could be a good move if there’s an early-bird discount from the taxing entity.
Borrowers who prefer to pay their bills themselves might be able to cancel their escrow accounts. And as long as they make payments on time, any of their reasons should be perfectly acceptable.
When homeowners let their bills slide, though, mortgage servicers immediately swing into action. For starters, the servicer might send an alert saying the insurance has lapsed and it will purchase a homeowner’s insurance policy of its own choosing.
Wait too long to pay taxes, and we know what’ll happen. It’s painful.
Some Borrowers Love Escrow; Others Aren’t So Keen
Escrow has its upsides. Here are three of them:
- It’s kind of like having a personal assistant! The borrower can have everything mortgage-related done in a single auto-payment. The mortgage servicer takes care of the distributions.
- Escrow keeps a borrower making steady payments. There is no need to suddenly have to come up with big chunks of money when the tax bill or insurance premium is due.
- Plus, there’s just one record to look at. The mortgage servicer keeps a running account of the monthly mortgage payments, broken down. It sends its customers statements, and an individual account record should be easily found on the servicer’s website.
Nevertheless, some borrowers just aren’t so keen on the idea. They can waive escrow if the lender says so. There may be a fee for the waiver.
Permission to close an escrow account often depends on whether the borrower has a perfect payment record for a year or more, keeps a high credit rating, and has paid down at least 20% of the home’s value. The rationale? Financially predictable borrowers who have already invested substantial amounts in their homes are unlikely to let their housing payments lapse.
And if a lapse does occur, the lender can force reinstatement of the escrow account.
Sometimes, There’s No Choice
Borrowers with certain loan types will have escrow as part of the bargain. For just four examples:
- All mortgages backed by Fannie and Freddie have escrow accounts. Exceptions are allowed only by the lender’s written waiver.
- FHA loans, too, all come with escrow accounts.
- Higher-priced mortgage loans used to require them, for the most part. But not always. And in January 2021, the Consumer Financial Protection Bureau added an “exemption from the requirement to establish escrow accounts for certain higher-priced mortgage loans.”
- Depending on what the lender says, borrowers with credit scores or down payments under a certain level may need to pay into escrow.
Being forced to pay into escrow can feel stressful, especially at the beginning when the borrower is forking over a chunk of money to establish up the account. But be aware that lenders sometimes give rewards to borrowers with escrow accounts. Preferred Rate / American Pacific Mortgage says:
Mortgage lenders sometimes offer mortgage points (0.25% discount) on the interest rate for homeowners who use an escrow account. Another option is to reduce closing costs in another category, such as the loan origination fee.
If you can get them, those breaks add up!
Anything Else a Borrower Should Know?
If you want to be escrow-free, ask your mortgage servicer if you may shut the account. Just be sure you really want to let go of the convenience. How much additional work can you expect to do if you cancel it? And will you have to submit proof of your bill payments to the company?
If you keep your escrow account, expect to pay more upfront than the minimum to cover your bills. Taxes and insurance costs can change, so your escrow payments may sometimes be higher than necessary. You will get a refund periodically for unused funds.
Watch your mail carefully, as escrow refunds can look more like regular statements than checks! The last thing any homeowner wants to do is leave money on the table.
Supporting References
Rebecca Lake for SmartAsset Advisors, LLC (a part of Financial Insight Technology): Should You Escrow Property Taxes and Insurance? (Apr. 6, 2022).
Christy Bieber for The Ascent (a part of Motley Fool): Why I Waived Escrow on My Mortgage (updated Jul. 19, 2021).
Kenneth R. Harney for The Washington Post: Major Lender Allows Borrowers to Go Without Escrow Accounts (Aug. 1, 2018).
And as linked.
Photo credits: Tima Miroshnichenko and Karolina Grabowska, via Pexels.