what is an escrow account

In many circumstances, buying or selling a home can be more complicated than you initially perceive. There are plenty of nuances that you’ll need to keep in mind, such as closing costs, title transfers, etc. But, you may encounter a situation where you need to handle an escrow account, something that not many are familiar with. So, what is an escrow account? Don’t worry, we’ve got you covered.

Let’s take a look at everything you need to know.

What Is an Escrow Account, Exactly?

Although handling an escrow account can seem complicated to those who are unfamiliar with the term, it’s a relatively straightforward process.

The purpose of an escrow account is to serve as a sort of savings account that is managed by your mortgage loan provider. Every time you make a payment on your mortgage, your provider will allocate a portion of that amount into your escrow account.

This money is then used to cover estimated expenses related to your insurance premiums and property taxes. Since the amounts deposited are simply projections of what you should be paying, there’s a chance that you’ll get a refund at the end of the year if you ended up overpaying.

Do You Always Need to Have One?

It’s up to your mortgage lender to determine whether or not you need to open an escrow account.

Another contributing factor is often the type of mortgage that you have. For example, those who take a vantage of government-provided loans (such as USDA or FHA loans) are required to have an escrow account.

When it comes to conventional mortgages, though, your lender will take a look at your financial situation, loan history, etc. to determine whether or not you need one.

Even if you aren’t required by your lender to open an escrow account, it’s not always a bad idea to do so. But, foregoing this option will require you to pay your insurance premiums and property taxes on your own.

Since these amounts need to be paid as a lump sum for the entire year in this case, this can be a difficult option for those who don’t have a large amount of cash on hand. Escrow accounts will allow you to spread these payments over a 12-month period as opposed to paying the required amount all at one time.

When Do You Make One?

If your lender requires you to have an escrow account, they will collect enough funds from you to open one after your loan has been approved. The account will remain active throughout the duration of your loan and will be managed by your provider accordingly.

If you would no longer like to have an escrow account be a factor, you may be able to negotiate with your lender about this responsibility.

How Does Your Lender Determine Your Escrow Amount?

In order to calculate how much money should be deposited into your escrow account, your lender will consider what insurance company you work with and what tax authority you are subject to. If you’ve owned property in the same area as the property in your current transaction, your lender may use previous insurance bills or taxes to determine this amount.

Your lender will also analyze your escrow account each year to ensure that they are allocating the right amount of money toward your financial obligations.

As previously mentioned, you may be entitled to a refund at the end of the year if they deposited too much money into this account. However, you could also be responsible for paying more if your lender did not contribute enough money to the escrow account.

In general, your lender will recommend that you pay the shortage amount as a lump sum. But, some lenders will allow you to distribute the amount that you owe in escrow shortage over the next 12 months of your escrow payments.

What About Escrow During The Buying Process?

Those who are looking to buy a home most likely heard the phrase ‘being in escrow.’

This refers to a situation where money is placed in a legal holding account until certain predetermined criteria have been satisfied. For example, this money may be kept in an escrow account until a proper inspection has taken place.

It’s done to prevent the buyer from quickly redacting their offer while also preventing the seller from prematurely depositing the money. If the offer is agreed-upon, this money will then be used to contribute towards your closing costs and down payment.

Afterward, your escrow account can be used to handle your property tax and insurance applications.

Occasionally, the amount in an escrow account is held after the completion of the sale. This will vary from transaction to transaction, but it typically involves separate terms that had already been agreed upon.

For example, if both the buyer and seller agreed that the current owner of the home has 14 days to vacate the property after the sale is completed, the money in escrow may be held during this period.

Dealing With an Escrow Account Can Seem Difficult

This all may seem complex, but it isn’t as tough as it appears.

With the above information about the answer to ‘what is an escrow account’ in mind, you’ll be well on your way toward ensuring that the process goes as smoothly as possible.

Want to learn more about how we can help? Feel free to get in touch with us today to see what we can do.

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