If you’re new to the home buying process, chances are good you’re learning plenty of new things about banking, the loan process, and escrow accounts. An escrow account is often required by lenders as part of an FHA home loan in order to pay property taxes, home insurance and other required expenses. But what are the rules governing escrow and what should the borrower know?
To begin, the Real Estate Settlement Procedures Act or RESPA states that escrow is NOT mandatory as a condition of applying for an FHA home loan. That said, the lender is free to require an escrow account–but the FHA does not insist upon one. When a lender does require money to be held in escrow, the financial institution is limited by RESPA–there’s a maximum calculation for the amount required for taxes, insurance and other expenses.
Some lenders require a “cushion” in the escrow account. RESPA laws do not require this, but a cushion is permitted as long as it does not exceed “one-sixth of the total amount of items paid out of the account, or approximately two months of escrow payments. If state law or mortgage documents allow for a lesser amount, the lesser amount prevails” according to the FHA official site.
Lenders who claim RESPA laws force them to require an escrow account, or that RESPA laws require a cushion in those accounts are, intentionally or mistakenly, misleading their customers. While it may seem like speculation to assert that some lenders do mislead FHA borrowers on this issue, apparently there was enough of a problem at one time for the FHA official site to address the practice directly:
“…many lenders have recently increased the escrow account cushion to the maximum allowed by law...” The FHA adds, “…Unfortunately, to avoid customer disapproval, some lenders may be giving their customers the impression that the HUD regulations require them to make this increase. This is a false impression. The lender, not HUD, has chosen to increase the cushion.”