If you’re buying a home, you will likely hear the word “escrow” a lot.
Escrow can have a few different functions throughout the home buying process, so it can be confusing.
What is an Escrow Account?
An escrow account is basically a savings account that is managed by a third party to temporarily hold large sums of money until an agreed-upon condition is met (like a purchase agreement).
Types of Escrow Accounts
In real estate, there are essentially two types of escrow accounts:
- To hold the home buyer’s good faith deposit until closing.
- To hold a homeowner’s funds for taxes and homeowners insurance.
Home Buying
When you purchase a home, you will typically be required to pay a good faith deposit or earnest money. This deposit shows the home seller that you are serious about buying the home. If the buyer backs out of the deal, the seller will get that money. If the purchase goes through, the deposit is applied to the buyer’s down payment.
In order to protect all parties, the deposit is held in an escrow account until closing.
Taxes and Insurance
Once you’ve bought the home, your mortgage company may require you to hold money for property taxes and homeowners insurance in an escrow account that your mortgage company manages. The escrow payment amount will be included in your monthly mortgage payment due. Then your mortgage company will pay the property taxes and your homeowner’s insurance when they come due.
Once a year, your mortgage company will send you an escrow analysis to determine if they’re collecting too much or too little. If they determine that you have paid too much, you’ll get a refund. If you have not paid enough, you will need to cover the difference. The mortgage company usually gives you a couple of options, including making a one-time payment or increasing the amount of your mortgage payment.
Benefits of an Escrow Account
The biggest benefit of an escrow account is that both the buyer and seller are protected during any real estate transaction.
For the home buyer, your deposit money is protected in case the purchase falls through due to a failed home inspection or the seller backs out. You are ensured to get your money back.
For the homeowner, an escrow account is basically a forced savings account for your property taxes and homeowner’s insurance. You don’t have to worry about saving it yourself. It’s all included in your monthly mortgage payment and paid for you on time.
Escrow accounts offer a lot of protection to the home buyer, the home seller, and the lender. While it may be burdensome to contribute to your escrow account based on estimates and experience possible changes to your monthly payment each year, overall, escrow accounts offer protection for all parties.