How do I Earn Interest on Escrow?

In the United States, when real estate is purchased with borrowed money — that is, a mortgage — the mortgage lender will make arrangements with the borrower not only for the periodic repayment of the principal and interest due on the mortgage loan, but will also frequently require that an escrow account be established to hold monthly contributions from the borrower for the future payment of hazard insurance premiums and real estate taxes. In many cases, these amounts can be substantial — in some cases, as much as $10,000 United States Dollars (USD) annually. Borrowers frequently want to know if they can earn interest on escrow accounts. There is no clear-cut answer to this question, however.

In the US, 14 states require that mortgage lenders pay interest on escrow accounts under certain conditions, and borrowers who meet those conditions in those states don't have to concern themselves with this issue. In some of those states, the law specifies minimum interest rates payable on such accounts, and in times when the prevailing interest rates are low, escrow accounts' interest rates might actually be higher than those available for savings and money market accounts.

The other 36 states, however, don't require lenders to pay interest on escrow accounts. Borrowers can earn interest on escrow funds, but the only way to do this is to close out their escrow accounts and pay the property taxes and insurance premiums themselves when due. Most mortgage lenders will permit borrowers to close out escrow accounts and pay their own insurance and tax bills when their equity — that is, the difference between the property's value and the outstanding mortgage balance — is at least 20% of the property value and their loans are at least one year old without any late payments in the previous 12 months. Some lenders will have additional requirements, and may also require borrowers to pay a fee to close an escrow account.

Thus, because there will usually be additional costs imposed on borrowers to close out their escrow accounts, borrowers should determine how long it will take to break even — that is, how many months or years it will take for the earned interest on escrow-type funds to surpass the amount lost to the lender's fees. It may not be financially prudent, for instance, to take over the responsibility for maintaining escrow funds in one's own account if the borrower plans to sell the property before that break-even point.

A borrower who meets the qualifications and decides to close an escrow account should establish an actual account — usually a savings account or a money market account, or short-term certificates of deposit (CDs), in either a bank or credit union — in which to store funds prior to disbursement to the taxing authority or insurance company. At this point, it's also prudent to explore the possibility of discounts or credits that might be available from either, and to take advantage of them. A benefit available to borrowers with credit cards that pay rewards on amounts spent is that they can charge their insurance and tax bills to those cards. Assuming that they then pay the credit card company immediately, they have the added advantage of the rewards from using the credit card.

There are benefits to assuming the responsibility for paying one's own insurance premiums and property taxes oneself, rather than assume the mortgage lender will properly pay those bills. First among these is the absolute knowledge that the bills are being paid and that the funds are properly accounted for; problems with escrow accounts are one of the major complaints American homeowners have with their mortgage lenders. In addition, a hidden benefit of paying one's own insurance premiums and real estate taxes is that when the mortgage has been paid off, there's no difficulty in transitioning the responsibility for such payments from the lender. In some cases, homeowners whose mortgages were retired weren't in the habit of paying homeowner's insurance premiums and didn't make them, and the insurance companies canceled the policies for non-payment of premium.