Buying a home often requires you to learn some new terminology, and escrow is a word you're likely to hear quite a bit. Take some of the hassle out of homebuying by knowing what mortgage escrow means — and how the process works.
What does escrow mean?
Escrow is an arrangement where a third party will hold funds for the purchase of a home or property until the transaction has been completed. Let’s say you’d like to buy a bike from a friend, but you wanted to make sure it’s delivered in working condition. You could have a mutual friend act as your ‘escrow’ holder. They’d make sure the seller knows you have the money for the bike, and they’ll ensure the bike is working as you’d expect.
How do escrow accounts work?
During your homebuying process, you may come across two types of escrow accounts.
In real estate transactions, the buyer’s good faith deposit (or “earnest money”) will commonly be held in an escrow account that the buyer or seller cannot touch until the transaction is complete.
After closing and during the term of the loan, an escrow account may be used to hold money meant for paying taxes and homeowner’s or private mortgage insurance premiums.
Let’s break down these types of real estate escrow accounts further.
Read more: Unsure which mortgage is right for your home purchase? Our quiz can help.
Escrow accounts when buying a home
So now you know when buying a home, escrow acts like a trusted middleman. But who manages an escrow account? Typically, an escrow agent or title company will, for a fee, set up and manage the escrow account before a purchase transaction, based on the terms of the escrow agreement between the buyer, seller and lender.
The escrow account typically holds the earnest money, down payment and other funds related to the sale. The escrow agent is responsible for making sure money held in the escrow account is distributed according to the escrow agreement or sales contract.
The escrow account remains open until the closing happens, or until some other condition is met, at which point the money is transferred to the seller.
Escrow accounts for taxes, insurance and PMI
After closing on a home, your mortgage loan servicer will use part of your monthly mortgage payment to be able to cover your property taxes, homeowners or flood insurance and private mortgage insurance (PMI), if applicable. Those funds are held in an escrow account.
If your mortgage has an escrow account, the loan servicer will provide an annual statement that shows your account history and a projection for the upcoming year. This can tell you whether you have enough money in escrow to cover what’s due. If not, your mortgage payments may have to increase to cover the difference. Keep in mind, some homeowner expenses like homeowners association fees will not be paid from the escrow account.
Is an escrow account required?
An escrow account for real estate transactions is not always required, but it is beneficial because it protects all the parties to a real estate transaction by ensuring money is only transferred to the seller once certain agreed-upon conditions are met, like a home inspection or the closing of the sale.
An escrow account during the life of the loan is often required by the terms of your mortgage contract or by law. Having an escrow account can help homeowners simplify the process of saving for and paying annual taxes and insurance costs on time throughout the duration of your mortgage.
Don’t be confused by mortgage escrow
If you’re a first-time homebuyer, the escrow process is probably new territory for you. But escrow serves an important purpose in your home journey.
