What is Mortgage Escrow?

Escrow ensures buyers and sellers in the real estate process are protected. As a homeowner, it ensures you will be able to pay for your property taxes and insurance. As a seller, it provides a layer of protection for the buyer’s deposit and helps facilitate the technicalities of the transfer of property.

As you progress in your homeownership journey, understanding and utilizing the different types of escrow accounts will both protect your money and ensure that all parts of your agreements are kept. Whether it’s the peace of mind that your good faith deposit is secure, or that your tax and insurance bills are incorporated to your monthly mortgage payments, we explain how escrow accounts can benefit you.

What is Mortgage Escrow?

In general, escrow refers to funds or property being held by a neutral third party. There are two common types of escrow utilized in real estate transactions:

• The first is deposit escrow. This type of escrow account holds your good faith deposit, also known as earnest money. 
• The second is a mortgage escrow account. This account is funded as a part of your monthly mortgage payment for the purpose of satisfying yearly tax and insurance costs.

Escrow Accounts for Home Buying

Your good faith deposit signals to the seller you are serious about purchasing the property, and the seller usually gets to keep it if the deal falls through. On the contrary, when your purchase is finalized, this deposit is applied to your down payment.

This deposit is held in escrow, which means it’s held in a separate account to protect both the buyer and seller.

In a similar fashion, funds can also be held in escrow past the close of your loan. This is referred to as escrow holdback and might happen if the seller stays in the home an extra month or if there’s an issue found during your final walkthrough. Another common scenario is funds remaining in escrow for new home construction mortgages until all of the work is verified, at which time the funds are released to the respective party.

Escrow Accounts for Taxes and Insurance

You’re probably already familiar with this type of escrow account. Any time you’re purchasing a home with a mortgage, you will most likely establish an escrow account with your loan. This escrow account is funded each month when you make your mortgage payment. A portion of that payment will be deposited in your escrow account. That way, when your annual taxes and insurance premiums come due, you will have already set aside money to cover those costs.

The servicer for your escrow account will disburse the payments on your behalf. They will also keep you updated about any changes that may be necessary to the amount of your monthly escrow deposits.

Changes to Your Monthly Escrow Contributions

Your mortgage escrow account’s purpose is to ensure you can fulfill your obligation of paying property taxes and insurance premiums when they come due. Because these amounts can vary, your loan servicer will try and meet this moving target by comparing these bills from year to year.

Your servicer will review your escrow account annually and make sure they aren’t collecting too much or too little. If too much was collected, you will get a refund of the difference remaining after paying the taxes and insurance. On the contrary, if not enough was collected, you will be responsible for covering the difference. If that happens, most lenders provide the option for you to make a one-time payment, or to add it to the amount of your monthly mortgage payment.

What Are Escrow Fees?

As you’re aware, there are many fees when it comes to buying a house. Like most other real estate services, there are fees associated with using escrow agents. Escrow services for your home purchase typically run between 1% to 2% of your final sale price. Keep in mind, though, that this is one of many expenses you can negotiate between the buyer and seller. 

Who Manages My Escrow Account?

During the home buying process, your escrow agent will handle the process of collecting and holding the earnest money, or good faith deposit. This agent might be the same as your title company. Escrow agents also hold the property deed and other documents related to the sale.

Then, once you close on your house, your mortgage servicer will manage your escrow account. The servicer will collect your monthly payments, keep your account current, and disburse payments when tax and insurance bills are due.

Do I Need an Escrow Account?

After reading about the ins and outs of escrow in real estate, you may now find yourself wondering if you really need an escrow account as part of your loan. If you pay for your property taxes and insurance on your own, you can lower your monthly mortgage payment, but remember the liability then falls solely on you to fulfill those obligations when they come due.

Another important note is that not all loans allow you to opt out of an escrow account. FHA loans, for example, require all borrowers to have one. Other types of loans, such as VA and conventional loans, only allow you to opt out if you meet certain eligibility requirements.

Benefits of Escrow Accounts

Your mortgage escrow account’s major benefit will be the peace of mind it gives you to know that you are contributing monthly to your tax and insurance obligations. This helps make those bills more manageable and can help alleviate the worry about having enough money to cover them.

Now that you’re well versed in the types and functions of escrow accounts, you understand how important these protections are to the mortgage process.

To learn more about the escrow requirements of specific mortgages, or if you need help deciding if you should opt for an escrow account when it’s not required, we encourage you to connect with one of our expert loan officers.