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Is Your Escrow Account Costing You Interest?
Published: 07/04/2011 by Kevin Mulligan
When you purchase a home with a mortgage the bank will require you to set aside several months worth of property taxes and homeowners insurance costs into an escrow account. In general terms, an escrow account is a third party account that holds those funds that two parties claim interest to and are often used in sales of large items. The money for the purchase is set aside until the item is delivered and then the funds are released.
For real estate purposes, the escrow account holds a few months worth of what would become the bank's external costs if you were to stop paying your mortgage. They would lose the principal and interest payment, but that becomes an internal write off. They are still required to pay the property taxes and keep insurance on the home to safeguard their new asset.
One common complaint about these escrow accounts is you are missing out on earning interest on the funds sitting in the escrow account. If you are a trustworthy individual who has an emergency fund, pays their bills on time, and would pay the property tax and homeowners insurance on your own, you might feel the escrow account is unnecessary.
But are you really missing out on that much interest?
Calculate Interest Lost to Escrow
To figure out how much money you are potentially missing out on, we need to know how much money is in the escrow account and how much interest you could earn on those funds.
How Much Money is Escrowed
Typically a bank will escrow 2 to 4 months worth of your property tax and homeowners insurance costs. These costs will vary from state to state, but can range from as little as $150 per month to $500 per month.
Assuming a long period of escrow, 4 months, and a high monthly escrow of $500, you would have $2,000 sitting in escrow.
How Much Interest Could You Earn
The amount of growth you could receive on your escrowed funds depends on your risk tolerance and how much you pursue finding high interest rates. The average “high-yield” savings account pays around 1% per year currently. You would earn $20 in interest over an entire year.
If you dug a little further you might find a rewards checking account paying 3%. That boosts your return to $60 per year.
If you took an even larger risk and invested the funds in mutual funds, you might earn 9%. That would boost your return to $180 per year. Then again you could lose all the money and not have a way to pay your taxes or insurance the next year.
At the end of the day your escrow account would have to be massive and the interest you would miss even more so for it really to be a substantial loss of interest income.
The Risk of Not Using an Escrow Account
That last point is why banks require you to have an escrow account. While you might be a reasonable person who wouldn't take extreme risks with the money, the bank can't take the risk of trusting you blindly. They have to protect their interests, and by forcing you to have some money set aside in case you slip up on your payments helps them do that.
