Which States Require Interest on Escrow Accounts?

Escrow accounts serve as a financial arrangement where a neutral third party holds funds or assets on behalf of two parties involved in a transaction until specific conditions are met. In the context of residential mortgages, an escrow account is commonly established by a lender to collect and disburse payments for property-related expenses, such as real estate taxes and homeowner’s insurance premiums. This mechanism ensures that these recurring obligations are paid on time, protecting both the homeowner’s property and the lender’s investment. While an escrow account simplifies financial management by consolidating these costs into monthly mortgage payments, a relevant aspect for homeowners is whether the funds held in these accounts accrue interest.

States Requiring Interest on Escrow Accounts

A limited number of states have enacted laws mandating that lenders pay interest on funds held in residential mortgage escrow accounts. These states include Alaska, California, Connecticut, Iowa, Maine, Maryland, Massachusetts, Minnesota, New Hampshire, New York, Oregon, Rhode Island, Utah, Vermont, and Wisconsin. This ensures borrowers receive a return on funds held by mortgage servicers, preventing lenders from benefiting from interest-free use. The specific interest rates and terms can vary by state statute.

For example, New York law generally requires mortgage investment institutions to pay at least two percent interest per year on escrow accounts for residential mortgages. This statutory rate provides a clear guideline for the minimum interest that must be credited to qualifying accounts. The application of these state laws, particularly to federally chartered banks, has been a subject of legal interpretation. While federal regulations do not universally require interest payments, state laws mandating interest can apply to federally chartered banks.

States Without Mandatory Interest on Escrow Accounts

The majority of states do not have laws requiring lenders to pay interest on residential mortgage escrow accounts. In these states, mortgage servicers are generally not obligated to provide any interest earnings on the funds held for property taxes and insurance. Federal regulations also do not mandate interest payments, so lenders are not required to do so unless a state legislates it.

Consequently, for homeowners in these numerous states, the money held in their escrow accounts typically does not generate any financial return. While some lenders might voluntarily offer interest on escrow accounts as a feature, this practice is not widespread. Homeowners should review their loan documents and state regulations to understand if their escrow funds are eligible for interest.

How Escrow Account Interest is Handled

When interest is required on an escrow account, its calculation is typically based on the average daily balance of the funds held within the account over a specified period. The interest rate applied is often a statutory rate set by the state, such as New York’s two percent, or tied to a financial index. This ensures a standardized and transparent method for determining the earnings on escrowed funds.

The earned interest is generally credited to the borrower’s account annually or at the time of loan payoff. Some lenders may apply the interest directly to the principal balance of the mortgage, while others may disburse it to the borrower via check. Mortgage servicers typically conduct an annual escrow analysis to review the account activity, adjust future payments, and ensure any earned interest or surplus funds are handled appropriately.

Interest earned on an escrow account is considered taxable income for the borrower. If the interest earned totals $10 or more in a calendar year, the mortgage company is required by the Internal Revenue Service (IRS) to issue Form 1099-INT to the borrower. This form reports the interest income, which must be included in the borrower’s federal income tax return. The interest is generally taxed at ordinary income rates, which vary based on the taxpayer’s overall income bracket.