Escrow is an often-misunderstood element of the home buying process. This added cost on top of a mortgage ensures that taxes and insurance are paid by keeping a separate account. There are, however, many rules pertaining to that account that you should know before purchasing property. These escrow rules refer to fees that could be added legally and illegally, interest, a cushion and the buyer's right to pay escrow themselves.
One of the most common escrow rules you should know about is whether the bank must hold the escrow money, taking an amount out each month, or whether you can pay the yearly insurance and taxes yourself. This is a tricky subject, because the answer can differs from place to place, so it will depend on the area where you are purchasing the property. Some places require you to have an escrow officer with the bank, but other places give you the option of managing the escrow account independently.
Local laws dictate other escrow rules as well. Some places require interest to be paid on escrow costs, often in the form of a monthly payment. Other places do not require these payments and need only the principal amount. Consult your loan officer on the rules in your area to ensure that unexpected interest payments are not added to the escrow process without your knowledge.
In the United States, no matter how large or small your escrow amount, the lender is prohibited from charging a fee for setting up an escrow account. Any lender in the U.S. that claims that there is an added fee when setting up this payment account is breaking the law and should be reported to the proper authorities. There is no U.S. law, however, regarding charging the buyer a fee for not setting up an escrow account and paying the taxes and insurance himself or herself. The logic that some states follow in this case is that this is a larger risk for banks, and the fee is a penalty for such risk.
The escrow rules referring to the amount of money you can put in your account as a cushion also differ from place to place. A cushion is any money added to the account over the required amount. A cushion often is used to cover rising property taxes. Most jurisdictions regulate how much this cushion can be, and you should discuss this rule with your lender.