Understanding Escrow and Escrow Accounts

When you close on a mortgage, your lender may set up a mortgage escrow account where part of your monthly loan payment is deposited to cover some of the costs associated with home ownership. The costs may include but are not limited to real estate taxes, insurance premiums and private mortgage insurance. This practice ensures that payments are made on time to third parties, such as county taxing authorities and insurance companies.

What is Escrow?

An escrow is a contractual arrangement in which a third party receives and disburses money or property for the primary transacting parties, with the disbursement dependent on conditions agreed to by the transacting parties. Your lender manages the escrow bank account. It's the bank or mortgage company’s responsibility to pay your bills on time. Your lender is liable for penalties should there be a missed or late payment.

What is an Escrow Account?

It's an account maintained by your lender to collect funds from you in order to pay the taxes and property insurance due on your home.

For Home Buying

For home buying, an escrow account is used to hold the deposit made on the purchase agreement. If the contract falls through because of the buyer, the seller usually gets to keep the money. If the home purchase goes through, the payment gets added the the buyer’s down payment. Occasionally, funds will be held in the account even after the closing of the house, this is called an escrow holdback.

For Taxes and Insurance

EX- After you purchase a home, your mortgage lender will establish an escrow account to pay for your taxes and homeowners insurance. Each month, your mortgage servicer takes a portion of your monthly mortgage payment and holds it in the escrow account until your tax and insurance payments are due.

The amount required for escrow is a moving target because your tax bill and insurance premiums can change from year to year. Your servicer will determine your escrow payments for the next year based on what bills they paid the previous year. To ensure there's enough cash in escrow, most lenders require a minimum of 2 months' worth of extra payments to be held in your account.

Benefits of An Escrow Account

For Home Buyers

An escrow account is essential to protect your deposit during a home sale. Giving your deposit directly to the seller before closing can risk losing the money if there are complications in the home inspections or agreement process. When the money is held by a third party, the buyer and seller can both rest assured that it will be returned according to the agreement.

For Homeowners 

An escrow account takes the pressure off the buyer to produce a lump sum to cover taxes and insurance. Since you're paying for your taxes and insurance throughout the year, the payments are much more manageable.

Another bonus is that you don't have to keep track of all the different due dates. When your tax bills and insurance premiums are due, your mortgage servicer will handle payments, ensuring they are paid every time, right on time. That way, you're not responsible for any late payments. Your servicer will even cover bills for you if your escrow account is short on funds, but you will have to pay back that money at a later date.

For Lenders

Lenders are keen on ensuring that your property taxes and insurance are paid on time for several reasons. Unpaid property taxes can result in a lien from the tax authority, potentially leading to foreclosure, which would be a financial loss for the lender. Additionally, if your homeowners insurance isn’t maintained, any significant damage or loss could drastically decrease the home’s value. By incorporating an escrow account with your loan, lenders can manage and guarantee these expenses are covered.

The Disadvantages of an Escrow Account

Although there aren’t any serious disadvantages of having an escrow account, here are a few considerations:

• Lower Escrow Estimates: the amount needed for your escrow is directly dependent on your property taxes and your homeowners insurance cost which varies over time. Lenders calculate this by looking at your previous year’s bills. However, when you new property is reassesed, the property tax amount may be different from the estimate. You may end up paying more if your property has increased in value
• High Monthly Mortgage Payments: The higher monthly mortgage payments associated with an escrow account is hardly considered a disadvantage. Because your escrow account is funded through your monthly payment, your monthly bill is technically higher, but you won’t have to pay taxes or insurance in a lump sum.

Escrow is an important part of home buying. You can ensure both the buyer and the seller are protected during a home sale and give the buyer a simpler way to pay taxes and insurance on the property. If you are ready to start your home buying process, looking for home loans or seeking more information, reach out to Modern Lending for a loan application or call 844-4-MODERN.