Another Bad Credit Mortgage Culprit: Lack of Escrow Accounts

As financial regulators and Congress probe deeply into the rise of delinquencies and foreclosures roiling the subprime (bad credit home loan) market, a key contributing factor is receiving increased attention:

The lack of mandatory escrow accounts.

According to some estimates, the majority of bad credit mortgage loans closed during the housing boom carried no escrow accounts for real estate taxes and hazard insurance.

That is in stark contrast to the prime mortgage market for consumers with good credit, where mandatory escrow accounts are routine.

“The people you’d think need an escrow the most aren’t required to have them, and the people who need them the least are forced to use them,” said Mike Calhoun, President and COO of the Center for Responsible Lending.

Escrow accounts are set up by a mortgage company to guarantee the timely payment of property tax bills and insurance premiums.

On top of principal and interest charges for the loan every month, the mortgage lender also collects pro-rated amounts of money to be paid when tax bills and insurance premiums come due during the year.

Escrows for insurance also are designed to protect the homeowner against loss in the event of a fire or other damage, and to cover the home loan lender’s interest in the property.

Subprime lenders dispense with mandatory escrows to keep monthly payments low. That’s an important lure since the mortgage rates they charge often are 3 percent or more above prime market rates, and many clients already have high debt loads and modest incomes.

But the lack of escrow accounts also places heavy responsibilities on the borrowers to accumulate sufficient funds during the course of the year to pay property tax and homeowner’s insurance bills, and to know when those bills come due.

Roy Rangel, a mortgage broker with Statewide Mortgage and Lending in San Antonio, calls the lack of escrow accounts “a killer” for financially strapped, unsophisticated borrowers “who don’t really understand that the payment they’re making every month isn’t everything that they owe.”

When those borrowers’ regular principal and interest payments jump by 40-50 percent from their artificially low introductory levels, “then they’re in really big trouble, they are drowning,” Rangel said.

Bottom line for consumers: If you have impaired credit or irregular income, recognize the greater level of risk when your monthly home mortgage payment doesn’t cover everything you owe.

SOURCE: Detroit Free Press