Understanding Escrow: The Why and How

A lot of first-time homebuyers have heard the term escrow, but don’t really know what it means when it comes to their mortgage. The team here at EPM wants to demystify some of the industry-specific words, phrases, and concepts you’re likely to encounter during the mortgage lending process, and break them down in practical terms so you can be educated and empowered while making critical decisions about your future. We are giving you a breakdown so you will know how it can benefit you whether you are buying, selling, or already own your home.

What is an Escrow account? 

Basically, when it comes to homeownership, an escrow account is where a 3rd party- in this case an escrow company, agent, or a mortgage servicer, holds a large sum of money until certain conditions are met.

There are 2 types of Escrow accounts when it comes to real estate:

The 1st protects a home buyer’s good faith deposit ( also known as earnest money). Once the conditions of the purchase agreement are met, the money is released to the seller.

• If the sale falls through due to buyer-fault, the seller keeps that earnest money and the transaction is over. If the sale goes through, it is applied to the down payment and the transaction is over.

•  Occasionally the buyer can hold back the earnest money due to conditions of the sale not being met by the seller. The money will not move from the account until conditions of the purchase agreement are met.

The 2nd is used throughout the life of the loan and held by your lender to pay taxes and insurance.

• Your lender will take a portion of your monthly mortgage payment and hold it in an escrow account until taxes and insurance are due. 

• Your lender will monitor your escrow account and  let you know if you are paying too much or too little based on the tax bill and insurance premiums that can change from year to year. If you have overpaid, you will be issued a refund, if you are underpaying, you will be given options to cover the difference.

Who Needs an Escrow Account?

An escrow account is an important way to protect homebuyers and sellers during the transaction, and it's a responsible way to ensure taxes and insurance are covered. If you’re a homebuyer, depending on the type of loan you qualify for, it may be required that you have an escrow account. If you qualify for a VA or conventional loan, there are different requirements for you to be able to opt out. All FHA loans require borrowers to have an escrow account. 

The benefits to an escrow account beyond protection, is peace of mind. The buyer and the seller can trust a third party escrow or title company to make sure the sale terms are met. And homeowners can be sure the taxes and insurance are covered and payments are made on time without having to keep track of dates. It’s often in everybody’s best interest to use an escrow account to make sure responsible financial decisions are being made. 

If you’re interested in starting the homebuying process and have more questions about escrow accounts, reach out to an EPM team member, and we can continue the discussion and help make sure you are making informed decisions when it comes to your mortgage.