Key Takeaways
- Escrow simplifies bill payments by managing taxes and insurance for you.
- It’s often required with low down payments for financial security.
- Escrow accounts adjust annually to match tax and insurance changes.
- Lenders review escrow accounts yearly to ensure accurate fund collection.
Article Summary
Escrow is a financial arrangement where a homeowner pays portions of their real estate tax and homeowners insurance monthly to their lender, who then pays the bills when due.
Escrow: Explained in Plain English
Escrow is a financial arrangement between a mortgage lender and a homeowner where:
- The homeowner pays portions of their property taxes and insurance premiums to the lender each month
- The lender holds these funds in a separate escrow account and pays the bills when they come due
Some mortgage types, like FHA mortgages and USDA mortgages, require buyers to set up an escrow account as part of the loan approval, with few exceptions.
Escrow is often required for conventional mortgages with low down payments. However, some lenders may also require escrow for larger down payments. If a buyer is given the option to waive escrow and chooses to do so, the lender may raise the interest rate or charge extra fees to offset their added risk.
Escrow accounts are established at closing. In some parts of the country, they are known as impound accounts.
A home buyer's escrow contribution changes annually as their tax and insurance bills change. Starting escrow balances and estimated payments are based on prior year expenses, with a two-month cushion added in to ensure the account has sufficient funds to cover increases in costs.
Mortgage companies review escrow accounts annually for accuracy and over-collection. When a lender determines it over-withheld money from a home buyer, it is required to issue an escrow refund.
Conversely, buyers must make up a difference if there is a shortfall. Escrow true-ups can be handled via a one-time payment or by adjusting a mortgage payment upward to cover the escrow account deficiency.
Consider a first-time home buyer who has just closed on a house. As part of their mortgage agreement, their lender sets up an escrow account to handle property taxes and homeowners insurance.
As part of their monthly mortgage payment, the homeowner pays a portion of their estimated annual taxes and insurance premiums which go into escrow. Then, when the tax and insurance bills come due, the lender uses the money in escrow to pay the homeowner's bills.
The escrow arrangement is helpful for the homeowner because it splits up two large annual bills into 12 smaller payments and offers a convenient and worry-free way to pay them. For the lender, escrow is a guarantee that the home's tax bill will stay current and its insurance policy will not lapse.
Common Questions About Escrow
Get answers to the most frequently asked questions about escrow accounts, including how they work, when payments change, and what happens when you pay off your mortgage.
