What is a Home Escrow Account?
As you go through the homebuying journey, one term you’re probably going to hear a few times is “escrow” or “in escrow.”
If you’re like us, you probably have no idea what “escrow” means — especially in a mortgage. You might know that it’s some kind of an official account, but not what it’s for exactly, how it works, or why you might want — or need — to get one.
The good news is that escrow accounts aren’t really all that complicated at their base form. Depending on your situation, you might even benefit from having one.
That said… here’s what you need to know about escrow accounts for mortgages.
What Are Escrow Accounts (And How Do They Work)?
When you get a mortgage loan, you’ll be required to pay a monthly mortgage payment. Most people think of this payment as consisting of two main components:
The amount that goes towards the loan balance (principal)
The amount that goes towards the interest (the cost of the loan)
For most homeowners, the monthly mortgage payment includes property taxes and homeowners insurance. These costs, which are calculated into the overall monthly mortgage payment, are added to a separate escrow account where they remain until they’re due. Once the insurance or taxes are due, your mortgage service will typically pay the bill using the escrow funds.
Most lenders and loan servicers will require you to have an escrow account. However, some might allow you to handle these charges — your property taxes and homeowners insurance — separately. The downside is that you’ll need to keep track of these expenses and pay them on time yourself.
Having an escrow account is generally considered a useful way to manage your property taxes and homeowners insurance. That’s because you don’t have to track these expenses separately. It can also make your life a little easier as a new homeowner, since you might not be used to these types of costs.
It’s important to note that each year an escrow analysis will occur. This is so that everything stays on track with how much you need to pay each month.
After the analysis, you might notice that your monthly mortgage payment has increased. This can happen if your insurance premiums or property taxes increase. In some cases, these fees could even decrease — resulting in a lower mortgage payment.
One other thing to note is that it’s possible to overpay into an escrow account. If you have $50 or more as a surplus in your account, your loan servicer has 30 days to refund that amount. If the surplus is less than $50, then it will go toward your escrow payments for the following year.
On the other hand, if the funds in the account aren’t enough to cover your taxes and insurance, you’ll typically need to pay this amount later.
(As an aside, there’s also an escrow account for rent. This is essentially a legal process that lets you as the tenant to pay rent to a third party instead of your landlord/property owner. There’s a whole legal process behind this and, as a homeowner, it’s not something you need to worry about at this stage).
Rules of an Escrow Account
There are quite a few escrow account rules. Not all of these rules will apply to you, but here are some of the big ones that could come up:
You might be required to make a money deposit into the account before completing the home purchase.
Any money placed into the escrow account will generally be kept securely there until the transaction is completed. At that point, the intended recipient will get it.
Any party involved in the homebuying or selling process may need to pay a facilitation pay.
Mortgage escrow accounts primarily exist to ensure the transaction goes smoothly for both the buyer and the seller. They keep any funds secure so that nothing happens to them, and they ensure that the intended recipient gets the money they should at the right time.
While it might seem like having an escrow account means you’re responsible for paying for more things, that’s not necessarily true. In reality, the items that are paid through an escrow account are items that you’d normally be responsible for.
Common Uses for an Escrow Account
Okay, so now that you know the basics, the next question is this:
What are the most common uses for an escrow account? Or, put another way, what are the main types of escrow accounts in a mortgage?
Here are the two main ones:
Pre-closing escrow account: This is a means to hold money, such as earnest money* or other funds intended to help the mortgage closing process go smoothly. The earnest money will remain in the account until the transaction is successful. If the transaction fails through no fault of the buyer’s, the money will be returned to them.
Post-closing escrow account: This account is designed to pay for insurance premiums, taxes, and any other charges related to the mortgage loan itself. This account will typically go through a yearly analysis. The required payment amount might change accordingly, based on the analysis results.
*Earnest money is money that you — the prospective buyer — put down to show that you are serious about buying a home. It can also be referred to as a good faith deposit. If the seller accepts your offer and the transaction is successful, the earnest money can be used to help with down payment or closing costs.
Pros and Cons of an Escrow Account
Like anything else, escrow accounts come with their pros and cons.
Pros of Escrow Accounts
The payments you owe for property taxes and homeowners insurance are automatic, meaning you don’t have to keep track of them. All you need to do is keep up with your regular monthly mortgage payments.
Since a portion of your monthly payments goes toward escrow, you’re more likely to have the amount needed to cover any necessary charges when they are due.
Having a home escrow account can help you stay on top of your payments.
Since an escrow account can streamline processes, you have one less thing to worry about as a new homeowner.
The money stored in the escrow account is kept safe and secure until the time comes to use it for payments.
Cons of Escrow Accounts
Since your service provider typically pays your taxes and homeowners insurance premium themselves, some homeowners might feel like they have less control over the process.
The estimates of what you owe could be too low. If this happens, you might end up having to pay more money later.
The estimates could also be too high. If this happens, you’ll either receive a refund or the money will go toward future payments. The downside is that it can result in a higher monthly payment, which could cause financial strain in the moment.
An escrow account may come with an initial set-up fee.
Calculations on Escrow Accounts
As mentioned above, there will typically be a yearly escrow analysis. Your loan servicer will usually also conduct this analysis when you first open an escrow account. This analysis will determine how much of your mortgage payment will go toward your taxes and insurance payments.
Once the loan servicer determines how much you owe for the year, they’ll divide that amount by 12 (for each month of the year). This is how much of your monthly mortgage payment will go toward your escrow payments.
Your servicer may also add a cushion equal to no more than 1/6 of the estimated amount needed for that year. In other words, they could require a minimum escrow account balance of two months’ worth of payments. This cushion helps ensure you have enough money in your account when the time comes to pay your property taxes or homeowners insurance.
Here’s an example of an escrow account based on general information for someone living in Wake County (North Carolina):
*Homeowners insurance based on the North Carolina average found by Insurance.com
**Calculations are estimates only. There may be additional costs, depending on your exact circumstances, home value, or location.
If you’re trying to calculate future payments, start by figuring out how much you paid last year on your property taxes. Alternatively, contact your local tax assessor's office for an estimate of the property taxes on similar properties in your area.
Do the same for your homeowners insurance. You can also contact your current insurance company to see if premiums are expected to rise.
Add these amounts together. Divide them by 12. This is how much of your monthly payment will likely go toward escrow next year.
How to Go About Opening an Escrow Account
Whether you like the idea of automating your property tax and homeowners insurance payments, or you’re required to have an escrow account, it doesn’t hurt to know how to go about opening one in the first place.
Here’s how to do it:
Choose an escrow company. An escrow account is often set up through your mortgage lender. If they or the seller’s agent doesn’t open an account automatically for you, or if your home loan doesn’t come with an account, you might have to ask them to set one up for you. Alternatively, you can contact a reputable third-party — like an independent escrow company or a bank — to set up an escrow account for you.
Contact the company. You may be able to set up an account via the phone, the company’s website, or in person. Only use secure channels — such as websites with digital safeguards.
Provide the key information. You’ll need certain information to open an escrow account. This may include the property’s address, the home’s sale price, the property type, your full name and contact info, the purchase agreement and any addendums, etc. It might also include information about your Homeowners’ Association (if you have one).
Wait for the escrow officer to open the account. An escrow officer will review your information and assign you an escrow number. They’ll then proceed with the process of opening the account. It can take anywhere from 30 to 60 days, on average, to open teh account.
Should I Opt Out of an Escrow Account?
First of all, it’s important to remember that you might be required to have an escrow account if you’re getting a home loan. This really does depend on the lender, the home loan type, and other unique or special circumstances.
If you wish to opt out or waive the escrow account requirement, however, you might be able to do so. You’ll need to sign an escrow waiver indicating that you agree to make insurance and tax payments separately. This will remove them from your monthly mortgage payment. You will still need to pay these things when they’re due — usually in a lump sum that’s due once or twice a year.
Waiving the escrow requirement could be a good idea if:
You want to handle everything yourself or don’t like the idea of automating payments.
You can reliably save up the required amount and pay the bills when they’re due.
Your monthly income fluctuates in a way that makes it easier to save up large amounts of money for property taxes and insurance some months while saving less during other months.
However, you might benefit from having an escrow account if:
You struggle to save up money during the year and can’t reliably make the lump-sum payments on time.
You prefer automation.
You’re already dealing with a lot as a new homeowner and want to simplify things a little.
You can comfortably afford a larger monthly mortgage payment that covers things like property taxes and insurance.
What Happens If I Don’t Pay What My Escrow Account Covers?
As the Consumer Finance Protection Bureau (CFPB) points out, failure to pay your property taxes could result in fines, penalties, and even a tax lien placed on your home by your local or state government.
If you still don’t pay, your home could go into foreclosure. This is essentially when the lender takes back the mortgaged property due to you not keeping up with payments. The more you fall behind on payments, the more likely you are to experience foreclosure and — ultimately — lose your home.
How Escrow Accounts Relate to the Homebuying Journey
The escrow account part of the homebuying process typically occurs when you make an offer (and offer earnest money) and/or when you close on your new home. If you’re still early on in your homebuying journey, you probably don’t need to worry about escrow right now.
But that doesn’t mean you shouldn’t be familiar with it. The more you know about these things, the easier — and less confusing — the process of buying a home will be.
Even if you’re still ages away from making an offer or buying real estate, it doesn’t hurt to know these things early on. So, keep learning and keep growing.
And for now…
Here’s to a simple, stress-free homebuying experience for you and yours!
