So you were told to put money in escrow, but you aren’t exactly sure what escrow is … (no, it’s not a French delicacy ????).
Escrow is an account commonly used in business transactions to make things easier for the parties involved in the deal – but for first-time homebuyers and owners, it can be a new and confusing term.
There’s no need to fear the e-word, however! Despite its fancy name, using escrow is rather easy.
Below, we provide simple answers to questions commonly asked about escrow by both buyers and owners. (Before you dive in, keep in mind that while many aspects of escrow are regulated by the federal government, states and banks can make some decisions about it too. Be sure to look into the specifics regarding your account.)
Here’s the tea:
What is escrow?
Escrow is when an unbiased and independent entity holds money, a deed or another asset until it is transferred when the terms of a deal are met or the funds are due to be paid to their respective parties.
Are there different types of escrow in real estate?
In the homeownership process, there are two types of escrow that are usually referred to by one of two names. There’s one for homebuyers (called a real estate escrow account or pre-closing escrow account) and one for homeowners (a mortgage escrow account or impound account).
Let’s say you’re a buyer. You’ll probably put your down payment (known as “earnest money” while in escrow) into a pre-closing escrow account for safe-keeping. These funds are held in escrow until closing or until the contract is canceled. If the contract is canceled, the escrow officer ensures the funds go to the correct party. If the contract closes, the funds are credited toward your down payment and/or closing costs.
For owners, a mortgage escrow account stores your estimated annual property taxes and insurance premiums, which you pay along with your mortgage each month. Money is paid out of the accounts by your mortgage company when the taxes or premiums are due. This way, homeowners stash away money for these bills as they go along, rather than trying to budget for big payments. This process also ensures that both the homeowner and the mortgage company are protected from the risk of an insurance lapse or having a lien placed on a property due to unpaid taxes.
At closing, your pre-closing escrow account is closed and, if your mortgage lender requires a mortgage escrow account (more on that below), money is transferred into this new account.
Who manages escrow accounts?
Various entities hold escrow accounts, from specialized agents to attorneys, title companies, and lenders.
This is an aspect of buying a home that you can relax about. (Phew!) Opening an escrow account on your behalf is one of the things that the pros are responsible for.
What does it mean for a buyer to be “in escrow”?
When asked how buying a house is going, we’ve all heard people say, “Great! I’m in escrow.” (Or, “Not so great, I’m falling out of escrow.)
Being “in escrow” is when your earnest money is sitting in a pre-closing account, ready to be disbursed to the seller, lender, real estate agent, real estate attorney (or whomever) at closing.
“Falling out of escrow” means the sale isn’t going through. This can happen for a number of reasons, such as the buyer not qualifying for a mortgage or the home inspection turning up unknown problems with the property. In this case, what happens to the escrowed money depends on the situation and whether anyone is at fault for the sale not going to closing.
Do owners need a mortgage escrow account?
An escrow account is often required by your mortgage company because of the financial protection it affords them. For example, being delinquent on your taxes can result in a lien or even a tax sale (a form of foreclosure). Not paying insurance could become a problem if the home gets damaged and you cannot afford to fix it. Either of these scenarios put your lender at risk of not getting paid back in full.
Some mortgage companies or products require escrow for the life of the loan. Others, however, only require it for a certain number of years and then allow you to opt-out if you wish, with the expectation that you will keep the taxes and insurance current. Mortgage companies that don’t require escrow accounts typically still offer them as a service to help homeowners keep up with the expenses of homeownership.
Does a buyer put money into a mortgage escrow account at closing?
If an escrow account is part of your mortgage, then yes. Typically, you’ll pay the first year homeowner’s insurance premium at closing plus two months’ worth of property taxes and insurance payments which will be deposited into your escrow account.
What’s the downside to a mortgage escrow account?
For those with varying incomes (say, you’re self-employed or work on commission) it can be easier to put bigger chunks of money toward taxes and insurance during more lucrative months. Others, meanwhile, just prefer to have control over their own money. Either way, you’ll need to be good at financial planning and saving to stay on track without one.
Even with an escrow account, administrative errors are possible, so you’ll want to pay attention to the amounts you should be and are paying (such as by monitoring your property tax rate), and when.
Do mortgage escrow accounts earn interest?
In most cases, no. Only 15 states require lenders to pay interest on escrow accounts, and there can be legal exceptions in those that do.
The states that do mandate interest for escrow are: Alaska, California, Connecticut, Iowa, Maine, Maryland, Massachusetts, Minnesota, New Hampshire, New York, Oregon, Rhode Island, Utah, Vermont and Wisconsin.
Can payments into mortgage escrow increase?
Yes, usually due to property tax hikes. If your rate goes up, you’ll have to pay more into the account. Your homeowners insurance premium can rise too, but it’s usually to a lesser degree.
But escrow payments can also drop. Your property taxes can go down or you may find a less expensive homeowners insurance policy. Although mortgage insurance isn’t technically held in your escrow account (it’s paid as soon as it’s collected monthly), it can decrease over time and, if you have a conventional mortgage, will eventually stop when you hit 20-22% equity.
Your escrow account will be analyzed once a year, and you can see the amounts that have been paid out of it in the analysis. Since what you pay is based on an estimate, sometimes you get some back, and other times you’ll owe a little extra.
Are escrowed property taxes deductible?
Yes again! Under a federal law enacted in 2018, up to $10,000 of your property taxes are deductible. However, deductions apply to the amount paid out of the account, not what you put into it.
Alrighty! Now that we answered your questions on escrow (we hope), here are some more topics you may be interested in:
How exactly do you take out a mortgage? We simplified the mortgage process into seven steps.
Is it still possible to buy a house during COVID-19? Indeed it is! The real estate market is going virtual.