People entering -- or reentering -- the housing market in these days of lower mortgage rates may have a surprise in store when they try to figure out possible monthly payments. They may already know that the price of the house isn't as important as what the price translates into as monthly payments on principal and interest, after making the down payment. They, or their lender, can quickly figure out, for example, that a $100,000 house with 10 percent down at a 10 percent interest rate translates into a monthly payment of about $790.
But if they figure, ``Sure, we can afford that,'' they could be in trouble. On top of that $790, or whatever, they'd better add $100 or $200 a month for a variety of ``escrow'' payments to the lender.
Until the late 1970s, many lenders did not require home buyers to have escrow accounts, where money is held for property taxes, homeowner insurance, and mortgage insurance. Some lenders, in fact, encouraged buyers to pay their own taxes and insurance, to save the lender one more piece of paper work. Other lenders just used escrow for mortgage insurance and property tax payments and let the buyers take care of homeowners' insurance bills.
But times have changed.
``All of this is now done with escrow accounts at the bank,'' says William H. James Jr., executive vice-president of Citizens Savings Mortgage Corporation in Canton, Ohio -- ``especially on government-backed loans and high-ratio loans.'' These two loans, he explains, are either guaranteed to the lender against borrower default by an agency of the federal government, like the Federal Housing Administration (FHA) or the Veterans Administration, or they are loans on which the buyer made less than a 20 percent down payment.
But the main reason lenders are demanding escrow for all insurance and property taxes is the ``secondary market.'' This is where lenders get more money for home mortgages by putting together ``pools'' of mortgages they have already written. Those pools are then turned into securities that are sold to investors who like the safety and income potential of mortgage-backed securities.
But these people also want to know there's no chance that the payments from their investments might stop because a homeowner was unable or unwilling to pay property taxes, or decided to let the house go underinsured because the premiums got too expensive.
``The secondary-market investors are requiring escrow to protect their interest in the property,'' says Charles Ferraro, assistant vice-president at the Bank of New England in Boston.
Simply put, the goal of escrow accounts is to make sure there's enough money to pay insurance and property taxes when they are due. Let's assume your property taxes are $1,200 a year and homeowner insurance is $500. That $1,700 will be divided into 12 payments, adding $141.66 to monthly principal and interest costs.
On top of this, federal law permits lenders to add the equivalent of two extra months' escrow to cover possible increases in property taxes and insurance. In this case, that would add $23.61 more a month, for a total monthly escrow payment of $165.27. Added to that original $790 for principal and interest, we're talking about a total monthly outlay of $955.27.
Even though you probably no longer have a choice about escrow payments, this does not mean you've completely lost control. You can, for example, still pick your own company for homeowner coverage. ``The buyer has full control over what company he uses,'' notes Mr. James in Canton. ``That's the law.''
If you pick a mutual insurance company that refunds a portion of your premiums as dividends every year, this check comes directly to you, not the lender.
You can -- and should -- also make sure you're being charged correctly. Even though the lender pays your taxes and insurance, the city and the insurance company send the bills to you first. Keep and review a copy of these bills before sending them to the lender. If you're not being charged enough, you may have to come up with a lump sum at the end of the year, or your monthly payments may jump next year.
On the other hand, the lender might be charging you too much. If there is extra money in the account at the end of the year, the lender should give you a refund or credit the account for next year, which could cut your monthly payments.
Most lenders will analyze your escrow accounts at least once a year (some do it every six months) to make sure they are collecting the right amount. If there's a shortfall or excess, or if taxes or insurance premiums change, your monthly payments will be adjusted accordingly.
In many states, lenders are not required to pay interest on escrow accounts, but some do anyway. If you are getting interest, expect a tax statement at the end of the year. Even if it's only $10, $20 or $30, the interest is taxable income.
There have been some complaints about lenders not calculating escrow accounts properly, not paying interest when they were supposed to, or not crediting surpluses, says Steven Cohen, a lawyer with the Federal Trade Commission.
If you have complaints, you can take them to the the lender, state banking agencies, the Department of Housing and Urban Development, or the FTC.
But close monitoring of your escrow account will probably head off most reasons for complaint.
If you have a question that would make a good subject for this column, please send it to Moneywise, The Christian Science Monitor, One Norway Street, Boston, Mass. 02115.