What is escrow? How does it work?

If you are looking to buy a home or are learning more before entering the housing market, there is a good chance that you have heard the term escrow. 

Escrow accounts are a neutral third party that holds onto important documents and funds during a transaction to ensure visibility and trustworthiness during a contract or deal. When everything is finalized and terms of an agreement are met, what is held in the escrow account will be transferred to the proper owner. 

Whether you are a seasoned homeowner or a first-time home buyer, knowing what an escrow account is and how it works is important when looking to buy a home with a mortgage. 

To start the process of buying a home with a mortgage, you can begin with an online application. 

What is an escrow account in real estate? 

When buying a home, an escrow account will hold funds, the deed and other important documentation during the closing process as well as part of your funds during your loan. 

An escrow account holds onto a property’s deed and a portion of the purchase price to reduce risk and give both the buyer and seller a sense of security during the homebuying process. 

How escrow works when buying a home 

When you get a mortgage to buy a home, an escrow account will be important in protecting your funds and a seller’s property. 

A buyer’s escrow account will hold their money as a sign to the sellers that they are prepared to purchase the home. The funds will stay there until all conditions and agreements are met. At closing, these funds are put toward the down payment and closing costs of the home. The same escrow account will also hold onto the deed of the house until the house is closed on. 

Buyers will continue to have an escrow account after they close on their home and their mortgage continues. 

Escrow for property taxes and homeowners insurance 

After your home purchase concludes and you continue with your mortgage, you will have a new escrow account for property taxes and homeowners insurance. 

During your mortgage, lenders will take care of your escrow account. A portion of your monthly mortgage payments will be put into your escrow account to ensure your property taxes and homeowners insurance are paid on time, reducing any risks of missed payments. 

Is an escrow account required? 

If you are planning to buy a home with a mortgage, an escrow account will be required. 

While they are required, escrow accounts are there for the benefit of the buyer and seller. An escrow account protects both the seller and buyer from risk or fraud during the homebuying process. 

Those planning to buy a home through cash or a private sale might not be required to have an escrow account during their transaction. 

When lenders require escrow 

Lenders will require escrow as you finalize your home loan and purchase as well as during the life of your loan. The escrow requirement is there to protect property, investment and interest. 

Can you waive escrow? 

Unless you are able to pay the full, or majority, cash amount for your home, escrow will be mandatory for your home purchase. Most lenders can waive escrows if you are able to make an 80% down payment (90% in California). 

After you have purchased your home and during your mortgage, you can request an escrow waiver. This will remove your escrow during your mortgage but will make you responsible for tax and homeowners insurance payments. 

What is an escrow shortage or surplus? 

If the amount in your escrow account is not what it is supposed to be, it is either a shortage or a surplus. 

An escrow shortage happens if the funds in your account are not enough to cover your expenses. This can happen when your property tax or insurance increases unexpectedly. In the case of an escrow shortage, you will need to provide any funds needed to make up the additional amount. 

With an escrow surplus, you will have more funds in your account than are needed. This could happen if any payments your account is used for are lowered unexpectedly. In the case of an escrow surplus, homeowners could either be issued a check for their extra funds or have that amount be put toward future payments. 

How to manage your escrow account effectively 

To effectively manage your escrow account, check your statements regularly and make sure you are in contact with your lender. 

Checking the statement of your escrow account regularly can let you track your payments and give you a heads up if your payments are changing. Your lender can also give you insight into when your payments might change. Staying in regular communication with your lender can be helpful in this case. 

To start your home mortgage and talk to a trusted lender, begin your home loan application online today. 

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