What escrow is and how it works

Escrow is a process used in many real estate transactions to protect both the buyer and seller. It involves placing funds, documents, or other assets with a neutral third party, known as an escrow agent, until the terms of the transaction are fulfilled.

It’s a good idea to check your escrow account balance regularly to ensure that it is accurate and up to date

In a typical real estate transaction, the buyer provides funds for the purchase of the property to the escrow agent. The seller provides the deed to the property to the escrow agent. The escrow agent holds onto these items until all of the terms of the purchase agreement have been met.

During the escrow period, the buyer will typically have a home inspection, appraisal, and obtain financing. The seller will make any necessary repairs or other agreed-upon conditions. Once all of the conditions are met, the transaction can be completed.

The escrow agent will then disburse the funds to the seller and transfer the deed to the buyer. This ensures that both parties have fulfilled their obligations under the purchase agreement before the transaction is completed.

In addition to real estate transactions, escrow can also be used in other situations, such as when a borrower is required to set aside funds for property taxes and insurance in a mortgage loan.

In this case, the lender will require the borrower to set up an escrow account to hold the funds. The lender will then use the funds to pay the property taxes and insurance premiums when they come due.

Escrow provides a level of security and protection for both parties in a transaction. It ensures that all of the terms of the agreement are met before the transaction is completed and helps to prevent fraud or other issues that could arise.

Why escrow is required for some mortgages

Escrow is often required for certain types of mortgages, particularly those that are backed by the government or those that have a higher loan-to-value ratio. There are several reasons why escrow is required for these types of mortgages:

Protects the lender: 

Escrow ensures that the borrower is making timely payments for property taxes and insurance. This protects the lender’s investment in the property, as the property serves as collateral for the loan.

Simplifies payment process: 

By having property taxes and insurance payments included in the monthly mortgage payment, borrowers don’t have to worry about making separate payments or missing payments.

Prevents payment delinquencies: 

Escrow helps prevent payment delinquencies by making sure that property taxes and insurance premiums are paid on time. This protects the borrower from penalties and potential foreclosure, as well as protecting the lender’s investment in the property.

Helps with budgeting: 

Including property taxes and insurance in the monthly mortgage payment helps borrowers budget their expenses more effectively, as they know exactly how much they need to pay each month.

In addition to these benefits, escrow can also provide peace of mind for both the borrower and the lender, as it ensures that all of the necessary payments are made on time and that the property is properly insured. While escrow is not always required for all mortgages, it can provide significant benefits for both borrowers and lenders in certain situations.

How to set up an escrow account

Setting up an escrow account is a relatively straightforward process. Here are the general steps to follow:

Determine if an escrow account is required: 

Some types of mortgages, such as FHA and VA loans, require borrowers to have an escrow account. Check with your lender to determine if an escrow account is required for your loan.

Calculate the escrow amount: 

The amount of funds required for escrow will depend on factors such as property taxes, insurance premiums, and any other fees or assessments related to the property. Your lender will typically calculate the escrow amount for you.

Provide funds for the initial deposit: 

At the time of closing, you will need to provide funds for the initial escrow deposit. This amount will typically cover a few months of property taxes and insurance premiums.

Set up automatic payments: 

Once the initial deposit has been made, your lender will typically set up automatic payments for your escrow account. Each month, a portion of your mortgage payment will be deposited into your escrow account to cover property taxes and insurance premiums.

Review your escrow account annually: 

Your escrow account will be reviewed annually to ensure that the proper amount is being collected to cover property taxes and insurance premiums. If there is a shortfall, your lender may adjust your monthly payment to make up the difference.

Overall, setting up an escrow account is a fairly simple process that can help ensure that your property taxes and insurance premiums are paid on time. It can also help simplify your monthly payments and provide peace of mind knowing that these expenses are being taken care of. If you have any questions about setting up an escrow account, be sure to consult with your lender.

What expenses are paid through an escrow account (e.g. property taxes, insurance, etc.)

An escrow account is typically used to pay for recurring expenses related to homeownership. The exact expenses that are paid through an escrow account can vary depending on the lender and the type of loan, but here are some of the most common expenses:

Property taxes: 

Property taxes are paid to the local government or municipality where the property is located. The amount of property tax owed is based on the assessed value of the property and is typically due twice a year.

Homeowners insurance: 

Homeowners insurance is designed to protect the property and its contents from damage or loss due to natural disasters, theft, or other events. The cost of homeowners insurance can vary depending on the location of the property, the age and condition of the home, and other factors.

Private mortgage insurance (PMI): 

PMI is typically required if a borrower puts less than 20% down on a home purchase. This insurance protects the lender in case the borrower defaults on the loan.

Flood insurance: 

Depending on the location of the property, flood insurance may be required to protect against damage caused by floods or other water-related events.

Other assessments: 

In some cases, there may be other assessments or fees related to the property that are paid through the escrow account. For example, there may be homeowner association fees, special assessments for improvements to the property, or other fees related to the property.

By paying these expenses through an escrow account, borrowers can ensure that they are making timely payments and avoid the risk of late fees or other penalties. Escrow accounts also help to simplify the payment process by combining these expenses into one monthly payment. If you have questions about what expenses are paid through your escrow account, be sure to contact your lender.

How to manage an escrow account

Managing an escrow account is an important part of homeownership. Here are some tips on how to effectively manage your escrow account:

Understand the terms of your mortgage: 

Make sure you understand what expenses are paid through your escrow account and how much is being collected each month. Review your mortgage statement regularly to ensure that payments are being made on time and that the account balance is sufficient to cover the expenses.

Keep track of property tax bills: 

Even though your property taxes are paid through your escrow account, it’s important to keep track of the bills and make sure they are being paid on time. Some lenders may send the bills directly to the escrow company, while others may send them to the borrower. Make sure you know who is responsible for receiving and paying the bills.

Review your insurance policies: 

Review your homeowners insurance policy annually to ensure that you have adequate coverage and that the policy is up to date. Notify your lender if you make any changes to your insurance policy, such as changing insurance providers or increasing your coverage limits.

Plan for changes in expenses: 

Keep in mind that the amount of money in your escrow account may need to be adjusted if expenses change. For example, if property taxes or insurance premiums increase, your monthly payment may need to be adjusted to ensure that there are enough funds in the account to cover the expenses.

Monitor your account regularly: 

It’s a good idea to check your escrow account balance regularly to ensure that it is accurate and up to date. If you notice any discrepancies, contact your lender or escrow company to resolve the issue.

By effectively managing your escrow account, you can ensure that your property taxes and insurance premiums are being paid on time and that you are prepared for any changes in expenses. If you have questions about how to manage your escrow account, be sure to contact your lender or escrow company for guidance.