Real Estate Tip: Escrow Accounts -- Do You Really Need Them?

If you have a mortgage on your property, whether it's for your personal residence or a real estate investment, chances are you have an escrow account. But if you are working on building wealth through real estate, you may want to take a hard look at your escrow account (or accounts, if you own more than one piece of real estate) and decide if you really need it.

Escrow accounts, also known as impound or reserve accounts, are often maintained by mortgage lenders on behalf of their borrowers. They typically work like this: the borrower's monthly payment covers the loan principal and interest, as well as a prorated amount that is deposited into the escrow account. The lender holds those funds and uses them to pay taxes and insurance for the property when those bills come due on an annual or semiannual basis.

There are a number of benefits to both lenders and borrowers. Serious problems can arise when taxes and insurance bills are not paid, so having that money in escrow helps reduce the lender's risk. The lender also benefits by having funds on deposit; most states don't require lenders to pay interest on escrow accounts, but they can certainly earn money on them. And secondary market buyers who purchase mortgage notes generally pay more for loans that have escrow accounts.

Many borrowers prefer the convenience of spreading the payment of a big bill over 12 months instead of having to make it at one time. Also, the lenders take care of tracking tax and insurance bills, so the borrower doesn't have to. However, if the value of the property is high--creating correspondingly high tax and insurance bills--the borrower is losing interest. Or, if you are a real estate investor with multiple properties, the total of your escrow accounts could be substantial. For example, if your taxes and insurance run a total of $12,000 a year and you have an escrow account, you're losing hundreds of dollars in simple interest and even more if you were to put that money in a higher-yield investment. And when you own several properties, the cost of the convenience of an escrow account increases accordingly. As part of your overall wealth-building strategy, you could put that money in a short-term investment (perhaps a property you intend to quick-turn) and let it work for you until you have to pay your taxes and insurance.

Policies on escrow accounts vary by lender and according to state law. Generally, escrow accounts are required when the loan-to-value ratio is 80 percent or higher. Some lenders charge a fee to waive the escrow account; before accepting such terms, be sure the cost of waiving escrow is less than the potential earnings from the interest.

Finally, be sure you have the discipline and resources to pay your property taxes and insurance on time before you take the step of eliminating your escrow account.

Jordan Taylor is the editor of Millionaire Mentor? Newsletter, which is published by Whitney Education Group, Inc.? To sign up for a free subscription, visit http://russwhitney.com