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 homebuyers and homeowners, it can be a new and confusing term.
There’s no need to fear the e-word. Despite its fancy name, using escrow is rather easy.
Below, we provide simple answers to common questions about escrow — and you can always learn more about all that’s involved in the homeownership process by taking Framework Homebuyer Ed.
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. Be sure to look into the specifics regarding your account.
What is escrow?
The word “escrow” refers to an account that holds your money until it’s paid out. The account is opened and managed by an objective third party.
What are the two types of escrow in real estate?
There are two types of escrow in real estate. 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, whoever is in charge of the account will ensure that the funds go to the correct party. If you do go to closing, the funds are credited toward your down payment and/or closing costs.
If you’re a homeowner, a mortgage escrow account stores your collects your estimated property taxes and insurance from your mortgage payment each month, and pays them when they’re due. This process protects both you and your mortgage lender from the risk of your taxes not being paid.
At closing, your pre-closing escrow account is closed and a new account is opened on your behalf by your mortgage lender.
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.
Head’s up: The pros that manage escrow accounts are human, and they’re working with technology which does have glitches sometimes. Check out our post on common escrow errors to learn how to watch out for mistakes in your account.
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:
- So … how exactly do you take out a mortgage? We simplified the mortgage process into seven steps.
- Facing financial hardship during COVID-19? You’re not alone! Here’s what to do if you’re worried about paying your mortgage.
