Escrow capitalization

Many borrowers feel that they are entitled to share the interest that the lender earns by investing these tax and insurance funds in the escrow account. If an escrow account were not required, a borrower could deposit tax and insurance money in an interest-bearing account until a payment was due.

There is one method of escrow collection in which the portion of the borrower’s monthly payment required to pay taxes and insurance is deducted each month from the balance owed on the mortgage. Then, when the institution makes a tax or insurance payment for the customer, the amount of the payment is added back to the principal balance. Since this reduces the amount of loan interest that a customer pays, it amounts to earning interest on escrow balances at the same rate of interest as on the mortgage loan. This method is sometimes called escrow capitalization and, although beneficial to consumers, it is seldom used by lending institutions today because of its high cost.