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Escrow or impound is an account that the lender sets aside to ensure that property  taxes and insurance will be paid on time on behalf of the home buyer. At closing, the lender may collect 2 - 6 months worth of property taxes when setting up the initial impound account - depending on the closing date. This protects the lender from tax liens and uninsured losses the borrower can't repay.

The amount in the escrow account varies during the year due to property tax assessments and property insurance premium adjustments. Due to these adjustments - your monthly mortgage payment will fluctuate from year to year even on long-term fixed-rate loans (with impound account - your monthly mortgage payment consists of Principal, Interest, and 1/12 of your property taxes and property insurance). Over the years, the lender typically will cover any shortfalls until it can adjust your monthly payment to make up for tax hikes and premium increases.

In some cases you can avoid escrow. Some lenders let you to pay your property taxes and home-insurance premiums especially if the loan-to-value ratio is below 80 percent. However, the lender may boosts the interest rate to compensate for the additional risk it is assuming. Once an escrow requirement is in place, it can be difficult to cancel it. If your loan is sold; as is common and there is nothing in the lender agreement that provides for cancellation of the escrow requirement you will have to live with the decision of your new mortgage servicer. Federal Housing Administration (FHA) insured mortgages require escrow accounts.

There is always a different reason for different people. Without an escrow account, you have to pay tax and insurance bills when they are due and they are often quite substantial.

a. Are you a good saver? The first thing to ask is whether you are a saver by nature. If not, you are better off having an escrow account. Escrow accounts help homeowners with budgeting as insurance and taxes fluctuate from year to year. Self-employed homeowners with income fluctuations may want to have the flexibility of paying for taxes and insurance directly. 

b. Where else can I put my cash?  If you are a good saver - you may open savings, money market accounts or certificates of deposit to set aside payments for escrow account.

c. Will it make difference with my loan?  In general - you will be rewarded with low rate by having an escrow account which can be substantial savings over the long haul. Home buyers also need to bring money to the closing table to fund the initial escrow account. Depending on the closing month - the amount for taxes and insurance could add up.

d. Whose responsibility is it? With an escrow account - it's the lender's responsibility to pay all of your tax bills in a timely manner. Lender will also be responsible to penalty should it occurs.