Understanding Escrow and Your Mortgage

When you get a mortgage loan, your arrangement may involve an escrow account. If you are unfamiliar with the term, it is important that as a homeowners you understand how an escrow actually works.

What Is an Escrow?

An escrow account is opened on behalf of the homeowner. When money is deposited into an escrow account it is held by a neutral third party generally known as the escrow agent who works for both the borrower and the lender. The role of the escrow agent is to release the money per the terms of the loan agreement instructions.

The purpose of an escrow account when it comes to a mortgage loan is for the lenders protection. By having an escrow account, the lender is assured that the borrower’s taxes and insurance on the home are being paid. This reduces the risk of liens being placed on the property which make it much harder to sell in the event of a mortgage loan default or a default paying the taxes. It also ensure that in the event of a fire or other disaster, the home insurance is paid as well. Otherwise, there would be no remaining collateral for the lender to access.

When Is an Escrow Account Opened?

At the closing of your mortgage loan, the lender will require an escrow account be opened on your behalf to cover property taxes and homeowner’s insurance premiums. An initial deposit will be made by the borrower to cover upfront costs and potentially a year’s worth of homeowners insurance and taxes, depending on the lender’s criteria. After the initial deposit is made, funds will continue to be deposited into your escrow account from the mortgage payments you make. Your mortgage payment will include funds dedicated to the escrow account. The escrow agent will have the information about when taxes and insurance premiums are due and will release the funds at that time.

Because taxes and insurance premiums change each year, the agent will review your escrow payments regularly. The escrow account will also have a cushion of funds in case a borrower misses a payment. Federal law prevents lenders from requiring more than two months worth of expenses to be held in escrow at a time.

Benefits of an Escrow

While lenders benefit from the added protection escrow accounts provide, borrowers will also find an escrow account has advantages. First, after the initial deposit the escrow account will require only a portion of the amount due towards taxes and insurance premiums. Essentially, you get a monthly payment arrangement for both costs instead of having to pay it all at once. It makes payments more manageable for the borrower. Secondly, borrowers do not have to remember to make payments for these bills. The escrow agent will automatically send payments out on behalf of the borrower as they come due.

Is Escrow Always Required?

Money in an escrow account typically does not earn interest in most states so some borrowers feel they are better off paying their own taxes and insurance. If you are paying more than 20% on a home purchase, the lender may waive your escrow requirement. While lenders may not require the escrow account, they may raise interest rates to compensate. If you open an escrow account and then change your mind, it will likely be difficult to cancel the account. You’ll need to ensure you understand the terms and conditions of the escrow before you go to closing on your mortgage.