Buying a house involves cumbersome process with many unknown and complicated topics. Even tough google can help you to search on topics, it doesn’t have any intelligence to recommend items which are importance and need attention at the right time. For example, do I need 3 point inspection for a new home or just one inspection? That’s why you need an helping hand, Realtors who can help and guide you every step of the way. Today, we are going to see an important topic which are overlooked by many buyers, Escrow Account & Waiver.
What is an Escrow Account?
The financial definition is that it’s a separate bank account for keeping money that is the property of others. An escrow account is where money is held by a party but does not belong to the party. Funds in an escrow account should not be commingled with the funds of the person or entity that is holding the funds. In some cases the person holding the funds in an escrow account is a completely independent third party called an escrow agent from a title company. In other cases, it is one of the parties to a transaction.
There are several reasons for using an escrow account. One main reason is to preserve the funds in the event of a bankruptcy of the person holding the funds. The funds in an escrow account do not belong to the person holding them and should not be able to be used to satisfy that person’s own creditors. Another reason to have an escrow account is to protect the funds from one party until certain conditions in the contract met by another party. That’s where independent escrow agent come into play. Agent’s make sure that the funds are only paid out when some specific conditions have been satisfied.
Where are escrow accounts used?
Escrow account are used many different transaction like real estate, small business, mortgage, attorney’s property transfer. One common example is the money held by the mortgage company to pay your yearly property taxes and insurance premiums. Your monthly payment includes that portion of amount which is placed in this fund. This amount is adjusted on a regular basis as your taxes and insurance increase. Another example is a real estate transaction where the buyer makes a deposit on a property. The deposit is usually held by one of real estate brokers rather than going to the seller. The broker deposits it in an escrow account created to hold client funds, rather than putting the money in the brokers own operating account.
Why lenders need an Escrow?
As I mentioned earlier, a deposit account maintained by the lender and funded by the borrower, from which the lender makes tax and insurance payments for the borrower as they come due. Lenders generally require escrow accounts. The rationale is that it prevents a weakening in the protection provided to the lender by the property. If your property is destroyed by a fire, the lender will have lost his collateral. Also if your taxes are left unpaid, your state can foreclose on your property in order to obtain payment and the lender could lose his collateral. Because of that the lender wants to make sure your insurance premium and property taxes are always paid. The amount in this account is based on the estimated amount necessary to pay these obligations each year.
To assure themselves that there will always be enough money in the account, lenders ask for more than they actually need as a “cushion.” In years past, many of them maintained unreasonably large cushions. To deal with that, the Department of Housing and Urban Development (HUD) issued a ruling that placed a ceiling on the size of escrow accounts, which in turn limited the amount the lender could ask the borrower to deposit at closing. The Real Estate Settlement Procedures Act (RESPA) sets limits on the amounts that a lender may require a borrower to put into an escrow account for purposes of paying taxes, hazard insurance and other charges related to the property. The rule is that the deposit cannot exceed the amount needed to prevent the balance from falling below an amount equal to two-months worth of tax and insurance payments at its lowest point during the year. Your lender or servicer will review the amount in the escrow account annually and notify you of a shortage or excess. Any excess of $50 or more must be returned to the borrower.
Why should I waive Escrow account?
There is no rule forcing you to have escrow for conventional loans. RESPA does not require lenders to impose an escrow account on borrowers. If you have a Conventional Loan and you do not have PMI (Private Mortgage Insurance), you have the option to close your escrow account and make your own tax and insurance payments. The more important reason to waive is to establish control over the payments. Lenders require escrow to assure that the insurance and tax payments will be made, and borrowers may want to avoid escrow for the same reason. Lenders occasionally screw up, and when this happens it can be a nightmare for the borrower. Another important reason is to have freedom to make payments anytime and change your insurance carrier anytime. Finally, earning interest on your payments by delaying them till end of year is a plus.
How to Avoid Escrow?
Most lenders will waive escrow requirements if the borrower makes a down payment of 20% or more. The logic of this waiver is that if the borrower has that much equity in the house, it is safe for the lender to rely upon the borrower’s self-interest to pay the taxes and insurance premiums. So, if you intend to put down 20% or more, let the loan officer know up front that you will not be escrowing. Some lender might requires you to pay a waiver fee like $250-$400. Just compare the advantage and make decision accordingly.
If you intend to put down less than 20%, it becomes more complicated and lenders won’t allow you to waive the escrow. If you are already escrowing, getting rid of it is not easy. You must convince the lender that it is in his interest to eliminate the requirement in your case.
Pros and Cons
Some important advantages are,
1. Piece of mind – You will have control over your tax and insurance premium payments and don’t have to worry that whether lender is properly making payment or not.
2. Earn Interest – By paying insurance and taxes yearly, you can get discount on insurance and also earn interest on the amount in your bank account.
3. Reduce closing cost – One more major items is that it reduces the closing cost. Prepaid’s is the amount lender wants you to pay during closing which includes 2-3 months of taxes and insurance payment ahead. It could total to few thousand dollars which you can reduce from your closing if you waive your escrow.
Only one disadvantage I can think of waiving escrow is that you need to govern your own insurance and tax payments properly and pay them on time to avoid penalties or foreclosures.
I am not recommending you to waive Escrow to any home buyers, just keep the option in mind when you are apply for mortgage and talk to your lender and make the decision accordingly depending on your situation and how you like to manage your payments. If you are comfortable enough to manage your payments, I would say go for it.
Some content courtesy: financialdictionary.com
About Vijaianand Thirnageswaram
I am a Proud Realtor of Texas, trying to guide and help clients to find their dream home and educate them to buy them for right price. I am also a Candidate for CFP who has more financial knowledge which allows me share and educate clients in any financial decision making process.
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