To escrow or not escrow, that is a question on some borrower’s minds. First of all, lenders prefer that borrowers escrow taxes and insurance. Thus, the lender is in control of making sure property taxes and insurances are paid on-time. Plus, most home loan programs require escrows for taxes and insurance. But, there are borrowers who prefer to pay their own taxes and insurance. Lenders call this an escrow waiver. Escrow waivers cost a little extra up-front but are available for a certain scenario.
What are Escrows?
In mortgage lending, escrows is a way of including mortgage insurance, property taxes, and any required insurances in a borrower’s monthly payment. Some areas of the country also call it impounds. Foremost, mortgage payments include principal & interest. An exception would be an interest only payment loan. Then, comes the escrow portion of the payment which may include monthly mortgage insurance, taxes, and insurance.
Basically, picture a bank account where you don’t make interest. So, every month a portion of the monthly payment is deposited into this account. Every month, it builds up a balance until PMI, taxes, or insurance are due. Once these are due, funds are withdrawn by the lender and paid to the source. Again, the account grows until the next amount is due for payment. Because PMI, taxes, and insurance may change over time, the escrow portion of the mortgage payment may also change.
Is an Escrow Waiver Allowed?
Again, lenders really prefer for borrowers to escrow their taxes and insurance. Obviously, if a borrower makes their monthly mortgage payment on-time, the lender is assured of two things. First, the home is always insured. Next, the property would not be foreclosed because of nonpayment of property taxes. So, if lenders prefer escrows, how can a borrower get an escrow waiver?
Escrow Waiver Fee
If you guessed there is a lender charge for an escrow waiver, you would be correct. Basically, in exchange for the additional payment risk a lender takes, they are going to charge up-front for it. There are two escrow waiver fee options: pay a small percentage of the loan amount or pay a little more interest rate. Typically, lenders charge .25% of the loan amount as an escrow waiver fee. Occasionally, a lender could charge as low as .125% of the loan amount. Instead of paying an up-front fee, a borrower may choose to pay a 1/8% higher interest rate. Most of the time, it makes sense to pay the fee rather than take an additional 1/8% higher interest rate. Maybe the only time it makes sense to pay the higher rate would be if the borrower pays off the loan very quickly.
Which Loan Programs Allow an Escrow Waiver?
So, when it comes to VA, FHA, USDA, and conventional loans, when can someone pay their own taxes and insurance? Again, the answer comes down to risk. The lower the down payment, the higher the risk is for the lender. Since the government loans known as VA, FHA, and USDA are all zero down to only 3.5% minimum down payment, lenders do require escrows. The same is true for conventional loans which exceed 80% of the purchase price or appraised value, whichever is less.
Therefore, that only leaves an escrow waiver available for a conventional loan which is 80% or less of the price or appraised value, whichever is less. The escrow waiver is allowed in both a refinance and a purchase. Additionally, borrowers combining an 80% first mortgage and a home equity line / loan may use this same rule. So, a cool strategy includes combining a first and second mortgage to not only avoid PMI, but also waive escrows.
Just in case you are thinking this question – Yes, 20% down on an FHA or VA loan would still require escrows. USDA loans will not allow 20% down payment.
Escrow Waiver Exceptions
Although a borrower may get a conventional loan and be at 80% or less, there are times where lenders will still require escrows. But, if the loan is under 80%, why can’t a borrower waive escrows every time? Sorry, but risk comes into play once again! Two exceptions to waiving escrows on a conventional loan include rental properties and when flood insurance is required.
Flood Insurance Requirement
Most of the time flood insurance is required and the loan to value equals 80% or less, lenders will allow an escrow waiver for taxes and homeowners insurance. But, when it comes to flood insurance, the risk is too much for lenders. In this case, lenders may only require escrows for flood insurance. When it comes to flood insurance, there are strategies to lower the insurance quote.
Rental Property Requirement
The escrow waiver rules mentioned apply to primary and secondary residences. Although, rental properties usually require escrows for any insurances and property taxes. Same reason – risk. What’s the risk of a rental property? When it comes to hard times, a borrower would make their payment on the primary residence before a rental. That’s basically what it comes down to.
Have questions on escrows or any other mortgage questions? Call an OVM Financial loan officer now.