Does a Mortgage Escrow Account Pay Interest?

If you a regular reader of this blog, you probably read that I signed up for using an escrow account for my mortgage when I did my mortgage refinance a few months ago. This is the first time I’ve used an escrow account. I did it because I didn’t want to pay the escrow waiver fee or give up the credit the lender offered to me for my trouble.

When you use an escrow account, you pay a few hundred dollars extra every month on top of your regular monthly mortgage payment. The mortgage servicer holds those money until your property tax and homeowners insurance bills come due. Then they use that money to pay the tax and insurance bills.

I was hoping the mortgage servicer would cancel the escrow account after the loan is sold and the servicing is transferred. But they said no. They won’t close it unless I pay them a fee. I will just stick with it.

One reason (not the only reason) people don’t like using an escrow account is that the money for tax and insurance stays with the mortgage servicer before the bills are due. People prefer to keep the money in their own account and earn interest on it. I made an escrow waiver fee breakeven spreadsheet for this purpose.

Are banks required to pay interest on mortgage escrow accounts? Like almost anything in finance, the answer to this naively simple question is very complicated. Way too complicated in my humble opinion. The requirements vary from state to state. Only lawyers are able to figure it out. Here’s a 29-page document that answers this one simple question:

State Interest On Escrow Laws For Residential Mortgage Loans, Prepared for the Mortgage Bankers Association by Buckley Kolar LLP, February 2007

According to the document, if you are in one of these 14 states, banks may be required to pay interest on your escrow account (there are exceptions):

  • California
  • Connecticut
  • Iowa
  • Maine
  • Maryland
  • Massachusetts
  • Minnesota
  • New Hampshire
  • New York
  • Oregon
  • Rhode Island
  • Utah
  • Vermont
  • Wisconsin

I was surprised to find out that my escrow account pays interest. Ironically the interest rate on my mortgage escrow account is higher than what I can earn in any money market fund right now and for the foreseeable future. I’m not complaining.

The laws must have been made when interest rate was high. That’s understandable because when interest rate was high, people complained most loudly if the banks didn’t pay interest on escrow accounts. The lawmakers never imagined that one day the Fed would cut the short-term interest rate to zero.

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Comments

  1. Hasan says

    I have a house in Maryland on a increasing-ownership contract with a financing company aimed at not dealing with interest because of religious reasons (in Islam, usury is a major sin). I am concerned about receiving interest on the escrow. Is there a way for me to not receive the interest, either by having the escrow stored in a non interest bearing account or by not having escrow at all?

  2. says

    Hasan – I’m sorry I don’t have an answer for you. You will have to ask the financing company if it requires escrow and how not to receive interest.

  3. Hasan says

    Thanks for the suggestion. I have contacted them about this. It seems though that the state law forces the financing company to pay interest to the home owner, even if he does not want to ‘earn’ the interest. Do you know of a process through which one might ask the government to allow the home owner to not have the escrow in a non-interest-bearing account?

  4. Scuba MN says

    Just wondering how the interest payment is made to the consumer? I have asked my mortgage company about it and they said they have too and I am coming up to my 1st anniversary so I am curious how I will receive that money.

  5. says

    Scuba MN – In my escrow account, the interest is credited to the escrow account every month and stays there. It will be used for tax and insurance together with the extra amount I pay into it every month. The interest is not paid out. The little bit of interest very likely will be eaten up by the increase in tax and insurance.

  6. yvonne says

    Well this is a surprise. We hold an account with Arundel Federal Savings Bank in Maryland and have never received any interest. When I asked the bank, they told me that they don’t have to pay interest. Please clarify.

  7. Donnie J Kaye says

    The banks and the feds must be loving this one. I have a small mortgage that i will be paying off when it comes time to redo. The economey still sucks, now lets put more burdens on the american people who can now bareley meet their mortgage payments. The banks will take the added on money and make interest on it and the american people will loose, again and again..

  8. Shellie says

    I have a question, my friend was involved in a law suit and when she received her settlement from the attorney she noticed from the itemized list that he sent (on everything owed) that he placed some money into an escrow account. after carefully looking over it she also noticed that he made 2,500 withing 2-2 1/2 weeks of placing that money into an escrow account and was able to pay himself back from a loan (instead of taking this money out of her settlement) she had made with in him. my question is can an escrow account be set up for other than paying mortgage and property taxes? can it be set up for personal use like if she wants to purchase a house next year or just have money to pay off some bills at the end of the year? if so where/how can I find out more about setting up an escrow account.

  9. Bill Jones says

    My mortgage company is holding over $20,000 of my money that I received for a loss to my home. (Storm Damge) and is holding it until all repairs are finished.
    Is the bank required to pay interest on this money while they hold it. Is this any different from money that is held in escrow for taxes?

  10. Neven Trieste says

    One addition – cancelling escrow will allow you to use a rewards credit card when you directly pay your homeowner’s insurance premium, an additional net savings equal to your cash back or other benefit (assuming you pay it off in the grace period)

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