What Escrow Accounts Cover
An escrow account collects monthly payments from you to cover expenses that come due annually or periodically. Your lender holds these funds and pays the bills when they're due.
The standard items that go into escrow include property taxes, homeowners insurance premiums, and flood insurance premiums if your property is in a flood zone. Ground rents also get escrowed in areas where they apply.
Say you buy a home where property taxes are $3,600 per year and homeowners insurance costs $1,200 annually. Your lender will collect $300 per month for taxes and $100 per month for insurance as part of your total mortgage payment. When the tax bill arrives, the lender pays it from your escrow account.
If you're paying for private mortgage insurance (PMI), those premiums must go into escrow. There's no waiver option for PMI escrow requirements.
Special Property Types and Escrow
Condos, co-ops, and planned unit developments (PUDs) get different treatment for property insurance. If the homeowners association or co-op corporation carries a blanket insurance policy covering your unit, you don't need to escrow for property insurance premiums.
You still need escrow for your individual flood insurance if required, plus property taxes and any other applicable items.
When Special Assessments Apply
If your property has a special assessment that wasn't paid at closing, the lender must set up escrow collections for it. The monthly escrow payment needs to accumulate enough funds to cover the assessment when it comes due.
A homeowners association might levy a $2,400 special assessment for roof repairs, payable in one year. Your lender would collect $200 per month in escrow to ensure the funds are available when the assessment is due.
How Lenders Can Waive Escrow Requirements
Lenders can waive escrow accounts for property taxes and insurance in many situations, but they need written policies governing these decisions. The waiver can't be based solely on your loan-to-value ratio.
The lender must also consider whether you have the financial ability to handle lump sum payments for taxes and insurance. Someone with strong cash reserves and stable income presents less risk than someone living paycheck to paycheck.
Even when escrow is waived, the mortgage documents still contain the standard escrow provisions. This means the lender can require you to establish an escrow account later if circumstances change.
Situations Where Waivers Aren't Allowed
Certain loan types don't allow escrow waivers. Cash-out refinances where you're financing unpaid property taxes into the new loan amount require escrow accounts. The lender needs assurance that future tax payments will be made on time.
PMI escrow requirements can never be waived. If you're paying for private mortgage insurance, those premiums must be collected through escrow.
Required Documentation and Compliance
Lenders must follow all federal and state regulations when calculating escrow amounts. This includes compliance with the Real Estate Settlement Procedures Act (RESPA), which governs how much can be collected upfront and maintained in the account.
Your lender needs to provide annual escrow statements showing how your money was collected and disbursed. If there's a shortage or surplus, the account gets adjusted accordingly.
Why These Rules Exist
Fannie Mae requires escrow accounts because they protect both you and the lender. Property taxes and insurance are critical to maintaining the property's value and the lender's security interest.
When borrowers pay these expenses directly, some fall behind on tax payments or let insurance lapse. This creates risk for everyone involved. Escrow accounts ensure these essential payments are made on time.
The rules are more flexible for borrowers with strong credit and financial capacity because they're less likely to miss these payments. But even then, the lender retains the right to require escrow if problems develop.
Common Issues That Complicate Escrow
Tax assessments can change significantly from year to year, especially in areas with rapid property value appreciation. Your escrow payment might need adjustment if taxes increase more than expected.
Insurance premiums can also fluctuate based on claims in your area or changes in coverage. Flood insurance requirements might be added if new flood maps are issued.
Some borrowers are surprised to learn that escrow accounts typically maintain a cushion beyond the actual expenses. This buffer helps ensure adequate funds are available when bills come due, but it means more of your money is tied up in the account.
References
For the official guidelines, see B2-1.5-04: Escrow Accounts in the Fannie Mae Selling Guide.
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Original Fannie Mae Guideline Text
Escrow Accounts
First mortgages generally must provide for the deposit of escrow funds to pay as they come due, including taxes, ground rents, premiums for property insurance, and premiums for flood insurance. However, escrow deposits for the payment of premiums for borrower-purchased mortgage insurance (if applicable) are mandatory. For the calculation of the monthly real estate tax payment lenders must comply with all federal and state regulations in calculating the amount to be collected for any established escrow account.
Fannie Mae does not require an escrow deposit for property or flood insurance premiums for an individual unit in a condo, co-op, or PUD when the project in which the unit is located is covered by a blanket insurance policy purchased by the homeowners’ association or co-op corporation.
If a special assessment levied against the property was not paid at loan closing, the borrower’s payment must include appropriate accruals to ensure that any estimated annual payment toward the assessment will be accumulated by the time it comes due.
For certain refinance transactions where the borrower is financing real estate taxes in the loan amount, an escrow account is required, subject to applicable laws or regulations. See B2-1.3-03, Cash-Out Refinance Transactions for more information.
Escrow Waivers
Fannie Mae advocates the establishment of an escrow account for the payment of taxes and insurance, particularly for borrowers with blemished credit histories or first-time homeowners.
Unless required by law, lenders may waive escrow account requirements for an individual first mortgage, provided the standard escrow provision remains in the mortgage loan legal documents. Lenders cannot waive an escrow account for certain refinance transactions (see above) or for the payment of premiums for borrower-purchased mortgage insurance (if applicable). When the requirement for an escrow account is waived, the lender must retain Fannie Mae’s right to enforce the requirement in appropriate circumstances.
Lenders must have a written policy governing the circumstances under which escrow accounts may be waived. When a lender permits escrow waivers, subject to the mortgage documents and applicable law, the lender’s written policies must provide that the waiver not be based solely on the LTV ratio of a loan, but also on whether the borrower has the financial ability to handle the lump sum payments of taxes, insurance, and other items described above.
