Many people borrow money to buy their house. In this context, lenders sometimes set up an “escrow” for property taxes, property insurance and private mortgage insurance (PMI).
Escrow literally means custody or control. An escrow account for buying a home is a separate bank account into which a homeowner deposits an equal monthly amount. The escrow account is under the custody or control of the lender, so called escrow. The lender uses the money accumulated in the escrow account to pay for irregular payments – usually twice a year – of property taxes and assessments. The escrow account can also be the source of funds for the payment of property insurance.
Lenders are always worried about homeowners not repaying their loans, leading to lenders foreclosing mortgages from lenders. Lenders expect the property to be worth less than the purchase price at the time of foreclosure. The general rule is that it is reasonable for the value of the property to decrease by around 20% between the time of purchase and the time of foreclosure. Therefore, lenders generally require borrowers to put down a deposit of at least 20% of the purchase price so that the lender is not shorthanded if or when the lender forecloses on a mortgage.
However, some buyers do not have a 20% down payment. In these cases, lenders will often give the buyer a loan for more than 80% of the home’s value, but require the homeowner to purchase insurance from a separate company that will pay for the shortage up to 20% in seizure case. This insurance is called Private Mortgage Insurance or PMI, which is also paid from the escrow account.
Notably, the PMI can usually be stopped when the outstanding loan amount is less than 80% of the home’s value. However, lenders’ software typically does not automatically remove the PMI until the loan amount to home value is approximately 78%. Therefore, it is always important for homeowners with PMI to check their loan amount against the value of the home to see if the PMI can be paused before the lender’s software automatically stops requiring the PMI. Sometimes several thousand dollars can be saved by requiring the PMI to cease before the lender’s software automatically stops requiring the PMI.
So, escrow accounts charge homeowners a regular amount each month and handle the payment of property taxes and assessments, property insurance, and PMI.
Of course, lenders like to have extra money in the escrow account, with a lot of caution. Therefore, to prevent lenders from abusing control to manage escrow accounts, there are federal rules regarding the number of months of bills the escrow account can have “reserved” or in hand. As a result, owners sometimes receive a letter and check for reimbursement if the reserves in the escrow account are too high. Similarly, if the escrow account becomes too low, for example due to increases in the amount of items paid for by escrow, the lender may increase the monthly escrow collection amount.
Lee R. Schroeder is an Ohio licensed attorney at Schroeder Law LLC in Putnam County. He limits his practice to business, real estate, estate planning and agricultural matters in Northwest Ohio. He can be reached at [email protected] or at 419-659-2058. This article is not intended to be used as legal advice, and specific advice should be sought from the licensed attorney of your choice based on the specific facts and circumstances facing you.