What is Escrow and How Does it Work?

What is an escrow account, and what role does it play when buying a house? You might have heard the term “escrow” used when chatting with a mortgage lender or real estate agent. But, if this is your first time buying a house, this term might not mean much to you.

An escrow account is a special savings account typically set up when you close on your mortgage loan. This special savings account is used to hold funds for future payments of items related to the property, including property taxes, homeowner’s insurance premiums, and flood insurance (if applicable).

At your closing, you’ll pay an initial amount for each of the items to start your escrow account.

What are the advantages of an escrow account?

An escrow account is a requirement for most mortgage loans. With this special savings account comes advantages you might not have thought of before:

• Your various payments will automatically be paid on time. You won’t have to worry about payment dates for the multiple costs through an escrow account. Your taxes and insurance are automatically delivered on time, so you avoid the risk of lapsed insurance coverage or delinquent taxes.
• Payment increases are covered. Your mortgage servicer allows for possible tax or insurance premiums increases when calculating your monthly escrow payment.
• Fund shortages are covered. Often mortgage servicers will pay taxes and insurance premiums when they are due, even if all the money for these bills has not yet been collected. Your upcoming escrow payments are adjusted to compensate for any shortages or overages.

If you include your taxes and insurance in your mortgage payment, you’ll see your escrow payments as a line item contributing to your monthly mortgage payment. As those costs are paid, you’ll see your taxes and insurance payments automatically deducted from your mortgage.

What is an earnest money deposit?

Earnest money is a deposit before closing to show you’re serious about buying. Earnest money is a layer of protection for the seller if the buyer backs out, usually around 1%-3% of the sale price. This deposit is held in an escrow account until closing. If everything goes smoothly during your closing process, your earnest money is applied to your down payment.