The Real Estate Settlement Procedures Act of 1974 (RESPA), administered by the U.S. Department of Housing and Urban Development (HUD), governs the practice of escrowing. Lenders must manage their escrow accounts in compliance with this federal law, state regulations and with the interpretations set out by HUD.  In addition, according to the 1990 Housing Bill, lenders must issue itemized statements of escrow accounts to borrowers on an annual basis. This law ensures that every lender follows this practice.

Escrows accounts guarantee that bills are paid on time.  The most obvious advantage of escrow accounts is that they automatically budget the borrower's tax and insurance responsibilities over the course of a year. Homeowners do not have to worry about coming up with several large, lump sum payments. If there is ever a fire in the home, or if the basement floods causing damage, the homeowner is assured that the home is protected by up-to-date insurance.

Because of escrow accounts, homeowners also do not need to be concerned about calculating unexpected increases in their taxes or insurance premiums. Your lender is responsible for allowing possible increases in these payments. Even when there are not enough funds in a mortgage escrow account to meet increased tax or insurance payments, your lender typically covers the bill without charging interest to the borrower.  The lender will send you a bill for the deficiency in the escrow account.  As a common practice, lenders pay increases when they are due even though all the money for these bills has not yet been collected from the homeowner.

The interests of investors in home mortgage loans are protected by escrow accounts. Escrowing has led to a healthier mortgage market by making home mortgages more attractive and secure as investments. As a result, loans with better terms and lower down payments are available to homebuyers.

Escrow accounts also benefit local governments by providing a more efficient, less expensive means of tax collection. Rather than working with millions of homeowners, municipalities need only collect from a few hundred lenders.

The law is very specific in setting limits on the amount that your lender may collect. Your lender may require a monthly payment of 1/12 of the total amount of estimated taxes, insurance premiums and other charges. Reasonably, the lender may collect an additional balance of not more than 1/6 of the estimated annual payments. Your lender is allowed by law to require additional money or eliminate the deficiency if your lender determines there will be or is a deficiency in the escrow accounts.