This Week's Q & A

Q: At what point can you ask that a mortgage lender stop requiring you to place funds in an escrow account and allow you to make the property tax payments yourself? A couple of people have told me that if your equity amounts to 50 percent of the property value, you can insist that the lender eliminate the escrow requirement and refund the balance of your escrow account. I’d also like to know if there is any limit on the amount lenders are allowed to hold in escrow. My mortgage company insists on maintaining a reserve that equals three months of payments, on top of the amount required to pay the quarterly real estate taxes. To add insult to injury, this lender only pays a paltry 1 percent interest on those funds. Are there any rules that apply here?

A: You’ve raised several questions about a subject that perplexes many borrowers, so let’s take them one at a time. Massachusetts law requires lenders to maintain tax escrow accounts for all residential mortgage loans on which the loan-to-value ratio exceeds 70 percent. So if the borrower’s equity is less than 30 percent, the lender is required to collect tax escrow payments. However, there is no requirement that lenders waive the escrow requirement for borrowers whose equity exceeds the statutory minimum. So there is no point at which you can demand the return of your escrow funds; you can request a waiver, but the lender is not required to approve it. Lenders can enforce the escrow requirement for the life of the loan, if they choose to do so. (The friends who told you otherwise may have been thinking about the law requiring mandatory elimination of private mortgage insurance under specified conditions.)

While applicable laws don’t require lenders to eliminate escrow payments at any point, they do limit the amount lenders can require borrowers to hold in reserve to a maximum of two months of escrow payments. If your escrow account balance exceeds that maximum, your lender is violating the law. But before you jump to that conclusion, consider that lenders can require two months of reserves for each escrow payment you make. So if you are required to escrow funds for hazard insurance and property taxes, your reserves could include up to two months of tax payments plus two months of insurance payments. Additionally, the escrow account a borrower establishes initially when the loan is closed might contain considerably more than a two-month reserve, because, depending on when the tax and insurance bills fall, the lender would collect enough to cover the first payments plus the two-month reserve. After that first payment is made, however, the escrow balance should not exceed the two-month maximum.

As for the interest paid on escrow accounts, state law requires lenders to pay interest on those funds, but the statute does not specify how much interest they must pay. The 1 percent your lender pays certainly is “paltry,” but it is by no means unusual. You won’t find too many lenders paying much more than that.

If you’re not sufficiently confused by these escrow rules, let me cloud the issue further by mentioning provisions in the RESPA (Real Estate Settlement Procedures Act) rules designed to ease the “payment shock” to borrowers resulting from sizable and often unanticipated increases in their required escrow payments. Such a jump might occur if a municipality boosts taxes or if a property assessed as raw land one year is assessed as a completed home the next, a not uncommon occurrence for people who purchase newly constructed homes. The RESPA rules suggest (but do not require) that lenders or servicers who anticipate a large second-year jump in the required escrow disbursements disclose that prospect to consumers, and give them the option of making higher payments during the first year to eliminate a huge jump the following year. But the operative word here is optional; those extra payments are voluntary and borrowers are not required to make them.