Question: Why do we really have to give the lender money, which is held in non-interest bearing accounts, to guarantee we will pay our own taxes and our own insurance policies? Your comments would be appreciated.
Answer: This is a subject on which consumers should make their voices heard in the halls of Congress and in your own State legislatures.
Lenders usually want a borrower to pay what is referred to as "P.I.T.I." This stands for principal, interest, taxes, and insurance, and if the borrower obtains a loan with equity of less than 20%, the borrower generally has to also pay for private mortgage insurance required by the lender.
The principal and interest portion of the mortgage payment is used to pay the monthly interest which accrues on the loan, and will reduce, ever so slowly, the outstanding principal balance.
But the extra payment for taxes and insurance is generally held by the lender in a non-interest bearing account, and when those real estate taxes and insurance premiums become due, the lender will then make the payment.
On a personal level, I am categorically opposed to any such escrow arrangement.
Consumers -- homeowners -- fully understand that if they do not pay their real estate taxes, their house can be sold at a tax sale. Consumers -- homeowners -- also fully understand that if their house is not insured, they can lose their house if a major catastrophe such as a fire occurs.
Most consumers are not going to let their home go to a tax sale, and are not going to let the insurance policy lapse. They usually have equity in their house, and they want to keep the roof over their head.
The practice works as follows. Let us assume the real estate taxes are $1,200.00 a year, and that the insurance policy is $600.00 a year. Dividing these total payments by 12, the homeowner is required to pay $150.00 each and every month to the lender. In approximately 15 states, the lender is required to pay interest on this escrow balance. (Search "states that pay interest on escrow accounts" on the internet.) But in the great majority of states in this country, consumers give hundreds of thousands, if not millions, of dollars to lenders, who keep this money -- presumably in escrow -- and then when the tax bill and the insurance premium comes due, the payment is made out of these escrowed funds.
The Real Estate Settlement Procedures Act permits a lender to have a cushion of two months above the actual amount needed to pay these taxes and insurance policies. Thus, lenders often take advantage of this extra requirement, and the consumer ends up paying even more than would be normally required.
The theory of this cushion is that if the taxes, for example, become due on the 15th of the month, the lender may not yet have received the homeowner's last payment before the lender has to pay the amount to the taxing authority. Thus, the lender obviously does not want to dig into its own pocket to make payments for the consumer.
The argument is made by lenders that if the consumer does not pay the real estate taxes, the house could be sold at a tax sale, and the lender would find that they have lost their investment. However, the United States Supreme Court, in a 1983 case entitled Mennonite Board of Missions v. Adams, made it clear that before any taxing authority can sell a house at a tax sale, all interested parties -- including lenders -- must be notified and given an opportunity to bring the tax bill current. Thus, the lender, as well as the homeowner -- should have ample opportunity to protect the house if a tax sale is scheduled by the taxing authorities.
Also, dealing with insurance, most lenders require the insurance company give the lender, as well as the homeowner, thirty days notice of cancellation before the policy is in fact terminated. Again, both the homeowner and the lender should have ample opportunity to bring the insurance policy current if there is a threatened cancellation of the insurance policy.
Let's face it. Lenders like the opportunity to play the float. While many lenders claim they do not have the use of these escrowed funds, they clearly can use them as compensating balances, or for other governmental financial requirements. And some unscrupulous lenders actually have been known to tap into these so-called escrowed funds until the tax and insurance bills are due.
There are several reasons why lenders should not be permitted to escrow for taxes and insurance.
I have represented clients where the lender either accidentally or purposely failed to pay the real estate taxes when they became due. The homeowner often has no knowledge of this omission, until the house is up for a tax sale. At that time, it might be too late for the homeowner to scramble to raise sufficient funds to pay the then-delinquent tax bill. By that time, penalties and interest will often have been added to the outstanding tax bill.
Second, many lenders are going out of business, or are in serious financial trouble. Additionally, many lenders are now selling their mortgages to outside investors, and these outside investors often just do not understand how the tax and the insurance bills work. Problems have occurred when the outside investor has not paid the real estate tax, simply because they did not know when it became due.
More importantly, the taxpayer should be able to control his or her financial picture. While it is true that some taxpayers cannot budget themselves, and like the idea of having the lender pay these taxes and insurance policies, the great majority of consumers are clearly able to manage and budget their own finances.
Here is one suggestion that might be satisfactory to lenders and homeowners. Each month, the homeowner should take 1/12th of the real estate taxes and insurance premiums that will become due, and deposit them in an interest-bearing savings account. This account can be with your mortgage lender, or with your own financial institution. When the taxes and insurance policy come due, you will have saved enough funds to pay these obligations, and will have had the use of your own money and made a little money to boot.