Why does your lending institution require you to escrow money so that it can pay your real estate tax and your homeowner’s insurance policy?
The lending community says escrows — or impounds — help you manage your budget. Instead of having to make a large payment yearly or semi-annually, you send one-twelfth of your tax obligation each month to the lender, who will pay the lump sum for you when it comes due. Lenders say the arrangement gives clients peace of mind and protects them from losing their homes by ensuring timely payments.
But consumer advocates say escrows are nothing more than a money-making device for lenders, who typically hold onto the escrow payments they receive each month without having to pay interest on the money. Homeowners do not need escrows, the consumer groups say: They are motivated to pay their insurance and real estate tax bills on time because they don’t want to risk losing their homes.
Finally, lenders sometimes fail to make the payment on time, exposing the homeowner to plenty of anguish as the parties try to resolve the issue and avert a tax sale.
Regardless of which point of view you embrace, you should know your rights.
If you are buying a home in the District and putting down 20 percent or more, you have the right to pay your own real estate taxes and insurance. In fact, D.C. law requires your lender to give you a separate written statement before you go to closing, advising you of this right. The same applies for refinancing if you have at least 20 percent equity in your home.
Some lenders try to get around this by telling borrowers: “Yes, you can avoid escrow if you will pay a quarter point of your loan amount at settlement.” Other lenders will allow borrowers to avoid escrows only if the mortgage interest rate is increased. In my opinion, borrowers should not be required to pay anything extra in order to take advantage of a consumer protection granted by law.
In Virginia, to my knowledge, there are no laws involving escrows. But lenders generally require escrows from consumers, though borrowers who have a long-standing relationship with their lenders can often avoid escrows if they are in good standing with their lenders.
Maryland law is partially consumer-friendly. A first trust lender must pay interest to the borrower on the funds in any escrow account — either 3 percent annually or the going rate on a regular savings account, whichever is greater. But there are exceptions. Interest does not have to be paid if the loan is purchased by an out-of-state lender through groups such as Fannie Mae or Freddie Mac and if that lender will service the loan. As a practical matter, I suspect that most Maryland loans will not accrue interest since they are serviced outside of the state.
Starting Oct. 1, however, Maryland will have new escrow account rules. If the lender determines that the escrows must be increased because the real estate tax has gone up, the lender cannot charge interest or fees on the amount of the increase for one year. But if the lender (or servicer) is required to advance its own funds to pay the tax or the insurance premium, then the lender can charge that interest — but only after notifying the borrower in writing that the advance was made and that interest will be charged on that advance.
In case you’re wondering what federal regulations have to say on the escrow front, federal rules do not require the lender to insist on an escrow account. But they “limit the maximum amount that a lender can require a borrower to maintain in an account,” according to the Department of Housing and Urban Development’s Web site.
If you do opt to escrow — or if you have to, how do you know if the escrow amount set by the lender is correct? Jack Guttentag, professor emeritus of finance at the University of Pennsylvania’s Wharton School, has a very clear explanation of how to calculate the escrow deposit required at closing on his Web site, The Mortgage Professor: www.mtgprofessor.com.
Lenders are known to make mistakes, and sometimes the lender does not pay the real estate tax or insurance. My suggestion: Every homeowner who is required to escrow should send the lender a letter — by certified mail, return receipt requested — demanding proof that the tax and the insurance has been paid. This letter should be sent no later than one month after the tax and the insurance premiums are due.
Benny L. Kass is a Washington lawyer. This column is not legal advice and should not be acted upon without obtaining your own legal counsel. For a free copy of the booklet “A Guide to Settlement on Your New Home,” send a self-addressed stamped envelope to Benny L. Kass, 1050 17th St. NW, Suite 1100, Washington, D.C. 20036.