No, for the most part, a bank is not required to pay interest on any escrow accounts (also known as mortgage impound accounts) it holds for its customers. Indeed, the U.S. Department of Housing and Urban Development (HUD) does not specify that escrowed money be held in interest-bearing accounts.

Escrow is a temporary condition of an item such as money or a piece of property that has been transferred to a third party with the intentions of delivery to a grantee as part of a binding agreement. Money or property in escrow are generally delivered by an escrow agent to a grantee upon satisfaction of outlined terms. Lawyers will most commonly act as escrow agents and work with a bank or financial institution to be escrow custodian.

While property is held in escrow, the buyer cannot take possession of or occupy the space. Real estate deals must clear a series of stages during the escrow process. An appraisal of the property must be conducted if it has not already been done. There may be issues with the transaction if the appraised value of the property is lower than the agreed upon purchase price.

Key Takeaways

  • Escrow accounts are used to safely hold large sums of money that have been earmarked for transactions such as the purchase of a home or property.
  • Federal regulation does not require custodians to pay interest on escrow accounts, however certain states may require it.
  • Even in these states, the interest received may be limited or negated altogether based on several other factors.

Escrow Interest Reform

There have been two attempts to pass legislation in 1992 and 1993 regarding the payment of interest on escrow bank accounts. Both of these proposals were declined, and there have not been any further attempts to change the escrow system since, at least on the federal level.

There are some exceptions on the state level. The states that do in fact require interest payments on escrow accounts are as follows: 

  • Alaska
  • California
  • Connecticut
  • Iowa
  • Maine
  • Maryland
  • Massachusetts
  • Minnesota
  • New Hampshire
  • New York 
  • Oregon
  • Rhode Island 
  • Utah 
  • Vermont 
  • Wisconsin

Escrow Interest in Practice

Even in these states, however, there may be legal exceptions that may preclude a bank from paying interest. Many of these states require that any interest earned through an escrow account be paid to the customer. This does not make escrow bank accounts an acceptable alternative to standard savings accounts for several key reasons. First, the HUD caps the total excess deposit amount at one-sixth of the total minimum amount to be deposited and paid out over the year. This limitation severely restricts any compounding customers might typically enjoy in a regular certificate of deposit (CD) or savings account.

Due to this fact, customers who manage their personal finances closely might actually benefit by investing the money they pay into an escrow bank account in other investment vehicles. For those whose credit and loans are highly leveraged already, it might be easiest to make smaller monthly payments rather than one large annual payment. Since mortgage escrows are designed to protect lenders from defaults, the bank ultimately makes the final decision on whether or not it will require a borrower to establish an escrow banking account.