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Can my mortgage lender require me to have an escrow account?

Generally, your mortgage lender can require you to have an escrow account if you borrowed more than 80 percent of the value of the property you bought. (The percentage you borrow against the valuation of the property is known as the loan-to-value ratio.) Each month, in addition to your mortgage payment, the lender collects a prorated amount to be held in escrow. Your lender applies this amount to your annual private mortgage insurance premiums, homeowners insurance premiums, and property taxes.

Private mortgage insurance protects the lender from loss in case it must foreclose on your property. You may petition to have this insurance coverage canceled once you can establish that your loan-to-value ratio is less than 80 percent. However, you'll still have to carry enough homeowners insurance to cover the replacement costs of the dwelling. Also, your property taxes may fluctuate from year to year, depending on the increase or decrease in your local property tax bill. Thus, the amount you may be required to keep in escrow may vary with changes in the valuation of your property. In addition to collecting the amounts necessary to meet these expenses, lenders typically hold a two-month surplus in escrow.

Only a handful of states have passed laws requiring lenders to pay you interest on the funds held in escrow accounts. In some states, you, the buyer, are allowed to set up your own separate account (known as a pledge account) for escrowing these funds. You are also responsible for making the property tax and insurance premium payments yourself. Under these circumstances, you earn interest on the funds in the pledge account.

If your loan-to-value ratio is less than 80 percent, you may be able to waive the need for an escrow account. To do so, let your lender or mortgage broker know up front in the lending process, because canceling an escrow account can be difficult once it's established. Your lender may require you to pay a one-time escrow waiver fee equivalent to one-quarter of one point. For example, if your mortgage is for $100,000, the fee would be $250.