Many mortgage lenders require their borrowers to pay extra with each mortgage payment to fund an escrow account. Lenders then use the dollars in this account to pay certain of these homeowners' bills. Unfortunately, no federal law requires that mortgage companies pay you interest on the money stashed in your escrow account. But depending on the state in which you live, your escrow account might generate interest anyway.
Although no federal law mandates that lenders pay interest on your escrow account, 15 states are required by state law to pay interest on escrow accounts.
How Escrow Works
If you have an escrow arrangement with your mortgage lender, you pay a certain amount extra with each mortgage payment. This money goes into an escrow account. When your property tax and homeowners insurance bills come due, your mortgage lender will dip into this account to pay these bills on your behalf. The theory is that this makes it less likely that homeowners will fail to pay these pricey bills either because of forgetfulness or an inability to save up the money throughout the year that they need to pay them.
The amount you pay in escrow varies depending on your insurance and property tax bills. If these bills add up to $6,000 a year, you'd need to provide your lender with at least $500 extra with each mortgage payment. Lenders, though, are allowed to collect a two-month cushion of escrow payments in case homeowners insurance and property tax bills increase. In this example, lenders would be allowed -- though not required -- to collect an extra $1,000 throughout the year. They'd most likely break this up into 12-month payments, meaning that over the year their borrowers would pay about $583 extra with each mortgage payment to provide lenders with $6,000 plus $1,000 in cushion funds.
The odds are that your escrow account will not generate interest. According to the U.S. Department of Housing and Urban Development, Congress rejected legislation in both 1992 and 1993 that would have forced lenders and banks to pay interest on their borrowers' escrow accounts. That legislation has not been reintroduced. Lenders can pay interest if they'd like, though they are not required to. Certain states, though, do require interest to be paid on escrow accounts. These 15 states are Alaska, California, Connecticut, Iowa, Maine, Maryland, Massachusetts, Minnesota, New Hampshire, New York, Oregon, Rhode Island, Utah, Vermont and Wisconsin.
The lack of interest payments is one reason some homeowners prefer to pay their property taxes and homeowners insurance on their own and forgo an escrow account. Such owners say that they can save their tax and insurance money in their own investment vehicles and make interest or earnings while doing so. If your lender gives you the option to forgo an escrow account, take a long look at your own financial habits to determine if you would be likely to save up enough money throughout the year to cover your tax and insurance bills.