When a buyer chooses a loan program with less than twenty per cent as a down payment, an escrow account for taxes and insurance is generally a requirement of the loan program. In most cases the only way to opt out of an escrow plan is to have twenty per cent down (or more) while choosing a conventional mortgage loan.
For the borrower the escrow account makes saving for these critical payments easy. Rather than saving for these bills and paying them on their own, a borrower allows the loan servicer to calculate the amount due and make the payments for them.
Mortgage lenders usually prefer it this way as well because it takes a worry off their mind. If a borrower were to fall behind on property tax payments it could significantly complicate the foreclosure process. Or if they were to fail to make an insurance payment, the lender's investment in the borrower's property could be at risk in the event of a disaster to the property.
If a borrower has an option to pay the property taxes and insurance on their own they might choose to do so primarily so that they might gain the interest on the money in their investments. While on most properties this amount might be fairly small, properties with high tax amounts can sometimes have several thousand dollars in the account, making a decision to opt out of escrow a potentially valuable solution.
At loan closing a lender must collect evidence that the borrower has paid for one full year's worth of insurance in advance. From there on the borrower will make monthly payments into the escrow account which will be saved for next year's billing cycle. Amounts collected for the escrow account are known as prepaid expenses.
Similarly with property taxes, the lender will collect several months worth of property taxes into the escrow account at loan closing. Depending upon when the next property tax bill is due, a borrower will likely not have paid enough into the escrow account through normal monthly payments to cover the bill. The way a lender ensures there is enough in the account to pay the bill is to collect enough property taxes into the escrow account to supplement the upcoming monthly payments so that there is enough in the escrow account by the time the tax bill comes due.
An escrow account provides an easy way to save for the property taxes and homeowner's insurance that are required for the borrower's home.
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