That is the proposition at the core of mortgage escrow services, in which lenders collect money on the borrower’s behalf as part of the monthly mortgage payment, then use those funds to pay the borrower’s real estate taxes and homeowner’s insurance, usually twice a year.

Government-insured loans such as those backed by the Federal Housing Administration or the Veterans Administration mandate escrow accounts for borrowers, mostly because they eliminate the risk that a borrower will default on taxes or fail to insure the house.

Borrowers with less than 20 percent equity in their homes must also use escrow accounts, except in California, where the threshold is 10 percent.

But many people choose the escrow option even when it is not required, and even though paying directly could save money.

“Borrowers tend to select it just because it’s a consumer-friendly budgeting vehicle,” said Michael Gross, the managing director of Countrywide Home Loans, one of the nation’s biggest real estate lenders.

Gross said that 61 percent of the company’s borrowers use escrow accounts even when they are not required and that this figure has remained steady during the past decade.

So although borrowers do not pay lenders for escrow programs, the service is not always free, depending on the prevailing interest rates. “You’re giving up interest or investment returns on the money you give the lender,” said Eric Tyson, the author of “Mortgages for Dummies” (Wiley, 2004).

A commonly overlooked element of escrow accounts is the reserve function, which allows lenders to impound more than the amount required to cover taxes and insurance.

Lenders say the reserve is meant to ease the pain of steep tax or insurance increases.

But if the borrower has a sufficient financial cushion to absorb such increases, the $30 or $50 monthly reserve payment may be better off in a money-market account or directed to violin lessons for the kids.

Those who call their lenders to eliminate their reserve payments may want to keep the telephone numbers handy. Each year, Countrywide (for example) automatically renews the reserve option even if the borrower opted out the previous year.

Source:

http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2007/02/25/REG9JO9MLU1.DTL