What Does Escrow Mean?
You could encounter the word “escrow” quite often when you are buying a home. It can mean different things during the buying process and once you own the property.
Knowing what it means and how it will affect you, is something you should know before buying a home.
It is extremely rare to ever enter into a real estate transaction without having escrow. Escrow funds are the glue that ensures parties in a transaction keep up their end of the contract.
We’re going to take a look at what is escrow and how it can benefit you, without ignoring the downsides as well. Escrow means different things depending on the circumstances of the transaction.
The escrow meaning in real estate is when money or property is held by a third party until certain things happen. The third party that manages the escrow helps to ensure that both sides of the home purchase are protected.
The use of escrows can benefit both buyers and sellers during a home sale.
An escrow account can also be called an impound account.
Escrow when buying a home could mean money is held in the account while certain conditions are completed. Typically it could mean contingencies have to be met by the buyer and the seller so that the purchase agreement is fulfilled.
Earnest Money is Escrowed
For example, in many real estate transactions, the seller’s real estate agent will hold earnest money in escrow until the sale is completed. The purchase contract will state how much money is to be placed into the escrow account.
Part of the escrow process is accounting for these funds at closing. The escrow provider will do this.
The escrow holder could also be a title company which would be considered a neutral third party. Whether a real estate agent or title company holds the monies in an impound account will often be determined by the state you live in.
If a title company holds the funds there will be an escrow officer assigned to the transaction.
Money can also be escrowed in an account when you have a mortgage to cover property taxes and homeowner’s insurance. This money is held in the account until these bills become due, which allows the cost to be spread out throughout the year.
So, an escrow account can have multiple purposes.
Escrow Account Types
It is a good idea to know the types of escrow accounts.
There are two main uses for escrow accounts when buying or owning a home; for the buyer’s earnest money deposit, or to hold money for insurance and tax payments.
Let’s look at what does in escrow mean and the type of escrow account you may see more closely:
Home Buying Escrow Accounts
Typically when you are buying a home, you will be required to provide a deposit as a way of showing good faith to the seller. This good faith or earnest money deposit gives the seller some protection if the contract is breached by the buyer.
If the buyer decides they don’t want to continue with the purchase, and this isn’t covered by any real estate contingencies, the seller will usually get to keep the deposit. But if things move forward successfully, the deposit the buyer has paid will go towards their down payment.
This deposit protects the seller, and using escrow protects the buyer. Using a third party to manage the escrow account means the buyer doesn’t pay the money directly to the seller. Otherwise, there could be potential problems if the buyer needs to get their deposit back from the seller.
Disbursement of Escrows Explained
There could be acrimony between the buyer and the seller, leading to the seller not releasing the deposit as they should.
The good faith deposit will remain in the escrow account until either the transaction closes, or the contract is ended. The escrow account can then be closed with the money either going towards the down payment, or to the seller if the buyer has broken the contract.
Occasionally there is a need for what is known as an escrow holdback. This is when funds are added to escrow by the buyer because the seller still needs to do something.
It could be that a problem was found on the final walk-through, and the seller is responsible for the repairs. This can also be used when it’s been agreed that the seller can continue to live in the home for a short while after closing.
Escrow can also be used if you are having a new home constructed. The money can remain in the escrow account until you are happy with the work, and it can be released to contractors.
Once You Own the Home See How Escrow Works
After you’ve closed on the property, your mortgage lender may require an escrow account for property tax and home insurance.
Tax and insurance payments will be added to your monthly mortgage payments, and then deposited in a mortgage escrow account until these payments are due.
However, property taxes and insurance premiums can change every year. While your lender will calculate your escrow payments based on last year’s figures, this might not be enough.
For this reason, lenders normally require a couple of months of extra payments in your escrow account to cover any increases in real estate taxes or insurance.
Mortgage Companies and Banks Like to Have an Escrow Cushion
Lenders do not want to end up with an escrow shortage. The additional monthly escrow payments are often referred to as having a minimum balance to cover what’s needed to be paid.
Typically, your mortgage lender will check the escrow account every year to make sure there is enough to cover the bills or to ensure you aren’t overpaying. If you are substantially in credit, you might even get an escrow refund.
While a refund like this is going to be a nice surprise, you could also get a more unpleasant result when the lender checks your escrow account. It might be the case that you haven’t paid enough money, and you will need to make up the difference.
You might get the option to pay a one-off fee, or they will increase your monthly mortgage payments.
The escrow requirement can be different from lender to lender. Some will do an annual escrow analysis. At the end of the year, adjustments can be made for the next year.
Bills Not Covered by Escrow Accounts
An escrow account is only going to cover ongoing property taxes and homeowner’s insurance. If you find yourself with a one-time tax bill thanks to the change in ownership or new construction, it isn’t going to come out of the escrows.
Utility bills and homeowners association fees will also be your responsibility and not paid for from the escrow account.
Can You Choose Not to Have an Escrow Account With Your Mortgage?
It is possible to take the responsibility for paying homeowners insurance premiums and property taxes yourself, sometimes. This has the benefit of reducing your monthly payment, but you’ll need to make sure you have enough money saved for the taxes and insurance when they become due.
You might only be given the opportunity to avoid having an escrow account if you meet certain criteria. Generally, with conventional loans, you need a down payment of 20% or more to have the option.
Mortgage Types Can Affect Escrows
The type of mortgage you’re using will also have a bearing on the escrow requirements. A conventional mortgage gives you a good chance to have the ability, not to escrow for insurance bills and real estate taxes.
If you are getting your mortgage through the FHA loans program, you will have to have an escrow account whatever your situation. The Federal Housing Administration will want a portion of your monthly mortgage payment going towards escrows.
Some lenders will only need an escrow account for some of these expenses. Perhaps they will only require property taxes to be paid out of an escrow account, for example.
Having Escrow For Private Mortgage Insurance
When you are putting less than a 20 percent down payment it is likely you will be required to pay PMI which protects the lender in the event you default. Lenders will require that you escrow your PMI payments on a monthly basis.
Having Escrow For Flood Insurance
If the home you are buying requires flood insurance, the lender will undoubtedly require that there be an escrow account for payment. As of January 1, 2016 lenders are required to have escrows for flood insurance. There are some exceptions made for small lenders.
You’ll need to check with the service provider you’re using but plan for paying into escrow for flood insurance.
How Are Escrow Accounts Managed?
In order to protect both sides of the transaction, a third party is needed to manage escrows. This can be done by an escrow company, an escrow agent, or a mortgage servicer.
Let’s look at who manages these accounts:
During the home buying process, your account could be managed through an escrow company or agent. These are sometimes known as mortgage servicing companies, and they might fulfill the role of a title company as well.
Not only will an escrow company be the third party to manage escrowed money, but they could also hold on to the deeds and other important documents.
Typically, the fee for these services is split between the buyer and the seller since they both benefit from it.
A Mortgage Loan Servicer
A mortgage servicer will deal with the administration of your mortgage. This will be from closing on the home until the loan has been paid off.
The servicer has to deal with making sure you pay on time, as well as managing the escrows.
Often, your lender will also be the servicer of your account. However, your lender might sell the rights to service your loan to another company. This could lead to larger chargers to manage your account, so you should make sure you know what the fees are going to be before you take the mortgage.
Lenders are required to detail monies being held in escrow as part of the loan estimate detailing all of the closing costs. The closing process cannot happen without doing so by law. Borrowers also get their breakout of costs in their loan documents as well.
The servicer will handle the property tax and homeowners insurance, so you don’t need to worry about when these bills are due. However, if you choose to switch to another insurance company, you will need to let the mortgage loan servicer know.
Doing so will allow them to update their policy information and continue to pay the insurance premium on time.
The Advantages of Escrows
Placing money in an escrow account has different benefits at different times during the home buying process and afterward. It offers you some protection when you are either buying or selling a home.
When you’re a homeowner, it makes sure you have property taxes and homeowners insurance covered.
Benefits of Escrows to Home Buyers
When you are buying a home, your escrow account will hold your deposit so that you can get this money back should contingencies give you the option to back out.
Perhaps you have a home inspection contingency, and major structural issues are uncovered by the inspector. This could lead you to not want to continue with the process and buy the home.
If you had simply handed over your deposit to the seller, you could potentially have some problems getting that money back. But holding the money in an account overseen by a third party avoids this problem.When there is a dispute about escrows the holder of the funds cannot release any money without both party's consent.Click To Tweet
Benefits of Escrows For Homeowners
The tax bill and insurance premiums will normally need to be paid in a large lump sum, but paying into an account monthly removes the shock of a large bill. Spreading the payments out over the year makes it easier to budget, without having to worry about huge bills around the corner.
It will also make sure that you pay on time since your lender will take full responsibility. This means you don’t have to worry about late payments that could affect your credit score or incur extra fees.
Even if there isn’t enough money in your account, you don’t have to worry as it will be covered (though you will have to make this up later).
Benefits of Escrows For Lenders
The reason impound accounts are required when you are a homeowner is that it benefits your lender. If you fail to pay your property tax, a lien could be placed on the property. This could lead to foreclosure, which could get expensive for the lender.
Without homeowners insurance, the lender could lose a lot of money if the home suffers serious damage. Escrows make sure that these bills are paid on time, protecting the lender.
The Negatives of Escrows
Most of the downsides of having escrows fall on the homeowner. It means higher mortgage payments each month, taking money out of your account that you could otherwise invest or spend.
There is also the problem of estimates being wrong. Since the cost of your property taxes or homeowners insurance is likely to change, you could find yourself with an unexpected bill even when you have been paying more each month.
Your monthly payments will be based on the previous year’s tax and insurance costs. While this is just an estimate, it can be a long way off. Your home will probably be reassessed when you first move in, which could lead to a big jump in the property taxes due. Increases in property taxes can happen for the first few years of your ownership before things settle down.
Since the amount you will need to pay into escrow is reassessed every year, you can’t guarantee that your monthly payments will stay the same. It will increase if there wasn’t enough to cover the bills, and only go down if you’ve been overpaying.
How Are Impound Accounts Regulated?
The governing body that oversees mortgage lenders’ escrow accounts is the Consumer Financial Protection Bureau. It is found under S 1024.17 Escrow Accounts.
Escrow Near Me
If you are selling for sale by owner with no real estate agents involved, you may find the need for having escrows held by a neutral party. You can search for an escrow company by doing an online search for escrows near me or escrow company near me.
Undoubtedly, you’ll get some companies that can hold the earnest monies during your transaction. You can and should have escrows when there is no Realtor involved. You’ll still want to have your interests protected.
There still can be escrows when there is no mortgage as well. If a buyer is paying cash for your home make sure you insist on the typical amount of money to be escrowed. Escrow companies near you can handle this as part of your home sale.
You could have to deal with escrows in a few different ways when buying a home. It can help protect your earnest money deposit when buying, also making paying taxes and insurance premiums easier and more manageable.
A lot of the time, an escrow account will be required when you own the home. But there is sometimes the option to deal with the tax and insurance yourself if you prefer. Often if you put more money down, one of the benefits will be forgoing an escrow account if you want. Though whether this is an option will depend on the type of home loan you are applying for.
You might like the idea of not having an impound account and dealing with the tax and insurance yourself, but there are some downsides. A lower monthly mortgage payment is going to be attractive to any homeowner, but it does mean taking on the responsibility of making sure these large bills are paid on time.
If you have any questions on something to do with escrows you may consider reaching out to a real estate attorney for legal advice.
Hopefully, you should now have a much better understanding of the importance of escrows. The concept of escrow is a vital part of most real estate deals to keep the appropriate parties honest.
About the author: The above Real Estate information on what is escrow in real estate was provided by Bill Gassett, a Nationally recognized leader in his field. Bill can be reached via email at email@example.com or by phone at 508-625-0191. Bill has helped people move in and out of many Metrowest towns for the last 34+ Years.
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