Buying a home? Then you’ve likely heard of escrow. What is escrow, really? It’s a term used frequently during the mortgage process, but it can be confusing. This post clarifies escrow accounts, their purpose, importance, and whether you need one.
What is Escrow: A Simple Explanation
So you are wondering, “what is escrow?” Well, to keep it simple, escrow is a neutral third party holding funds or assets during a transaction. This ensures a smooth process and protects both parties involved. It’s like a referee in a financial game.
Your dream home is waiting! Take the first step towards owning it with a mortgage pre-approval. Know your budget, shop with confidence, and turn your homeownership dreams into reality with Allied Mortgage.
Types of Escrow Accounts in Real Estate
There are two main types of escrow accounts in real estate transactions.
Escrow for Home Buying
This account safeguards your earnest money when making an offer. This shows the seller your commitment to the purchase price. An escrow agent, often from a title company or an independent professional, manages the account.
The funds are held securely until closing, protecting both buyer and seller. The money goes to the seller if the sale closes successfully. Otherwise, it’s returned to the buyer.
Escrow for Property Taxes and Insurance
After buying, your lender might establish an escrow account to manage property taxes and homeowners insurance. A portion of your monthly mortgage payment goes into this account and is allocated to yearly taxes and insurance payments.
The lender uses these funds to pay those bills for you, preventing penalties or foreclosure
How Escrow Works After Closing
Your lender typically reviews your escrow account annually to ensure it sufficiently covers the cost of property taxes. This review is crucial in maintaining a balanced homeowners escrow account and avoiding any potential issues.
After the review, your lender might issue a refund if there’s an overage in your escrow account. On the other hand, you may owe more if there’s a shortage. In some cases, underestimations may result in late payments to the tax authority, which can lead to additional penalties and fines.
Accurate estimates are essential in maintaining a healthy mortgage escrow account and ensuring timely payments to the tax authority. This, in turn, helps with wealth planning and avoiding any potential financial burdens.
By understanding how escrow works after closing, you can better manage your finances and avoid any potential issues related to property taxes.
Who Manages the Escrow Account
For home purchases, a title or escrow company, or an escrow agent, manages the initial escrow process, including the earnest money deposit. They manage these funds as well as documentation relating to the transaction.
After closing, the mortgage servicer manages the escrow account for insurance and taxes.
Benefits of an Escrow Account
Escrow accounts provide peace of mind. They prevent unexpected large tax or insurance bills, streamlining your finances. By paying a portion of these expenses monthly along with your mortgage, these larger annual payments become much more manageable.
Drawbacks of Escrow Accounts
One significant drawback of escrow accounts is the higher monthly mortgage payment. This is because the payment includes not only the mortgage principal and interest but also the tax and insurance portions. This increased payment can impact your ability to afford higher monthly mortgage payments overall, and subsequently affect your monthly escrow contributions, which go toward taxes and insurance.
Another concern is the potential inaccuracies in tax payment estimations, which can fluctuate from year to year. These estimates are subject to change during the annual escrow analysis, which can lead to unexpected adjustments to your monthly payments. To mitigate this risk, it’s helpful to have a money market or CD with high-interest-bearing returns at your bank (or a little extra savings in your bank account), which can provide a cushion in case the estimations are too high.
Do You Need an Escrow Account?
Some loans, like FHA loans and VA Loans require escrow accounts. Lenders sometimes require escrow for new homeowners, especially when loan resources show an outstanding amount to other lenders. This is regardless if its a student loan or business banking debt.
Sometimes the rules might be a little more forgiving on certain loan products, such as VA Loans, but they always depend on the lender’s determination and not always guaranteed. Loan calculators for VA mortgages may not give an entirely accurate account of lender-by-lender changes in escrow stipulations. Speak to an experienced mortgage professional about how a VA loan impacts your options when making monthly payments on your escrow account.
Other loans may let you opt out of escrow payments and manage your own taxes and insurance, which results in lower monthly mortgage payments. However, it also places a greater financial burden on you, as this option usually means a lump sum each time your insurance or taxes come due.
You should contact a professional loan lender for answers about the benefits and usage of escrow accounts and how they protect each party involved in a property transaction. Whether an escrow account serves you usually can only be determined through detailed assessment with a professional.
House hunting? Get pre-approved and shop with confidence! Know your budget and make stronger offers. Start your journey with Allied Mortgage today.
Can You Remove Escrow From Your Existing Mortgage?
Removing escrow from an existing mortgage is contingent upon several factors, including loan balance, timely payment history, and equity (typically, you can remove escrow once you have 20% equity).
Additionally, you’ll need to provide proof of homeowners insurance and meet other lender-specific criteria, as well as comply with state-by-state lien/mortgage stipulations. These requirements can impact the removal of escrow and affect the outcome of your transaction.
It’s recommended to seek expert advice from a professional when considering removing escrow. Consulting with someone experienced in this area can help clarify escrow rules, stipulations, and whether an account works for you or not. This guidance can simplify the process and ensure you make an informed decision.
Imagine stepping into your perfect home. Make it happen with a mortgage pre-approval from Allied Mortgage. Discover your buying power and bring your dream home within reach today!
Conclusion
What is escrow? This post covered what escrow accounts are, how they function in real estate, from purchasing to bill paying. Consulting a financial advisor can help clarify how escrow might affect your personal financial situation, especially given your unique tax planning circumstances. There is a myriad of factors that play a role such as retirement plan setup, savings account availability, auto loan outstanding amounts, whether the property will be primary residence, vacation home, or investment rental.
Before embarking on a home-buying journey, it is essential to connect with a reputable advisor/expert in order to ensure proper steps are being made towards the desired outcome based on what your personal short/long-term objectives are and how escrow will affect you.
FAQs About What is Escrow
What does escrow on a house mean?
Escrow on a house is an account your lender uses to pay property taxes and homeowners insurance premiums. The funds come from a portion of your monthly mortgage payment.
Is it good to be in escrow?
This depends on your situation. Escrow simplifies bill paying but increases monthly payments. Consider your personal finances, small business ownership, wealth planning and discuss options with someone you trust such as an investment manager or business advisor, about the pros/cons of whether paying property into escrow works for your personal needs and tax planning.
Why do people pay escrow?
It’s often required by lenders, especially for new homebuyers and certain types of loans like FHA or VA loans, regardless of your DTI (Debt-to-income) ratio or even credit card standing. Some loans may permit the waiving of an escrow account, but having open communication between yourself and the loan servicer is essential so as not to be caught by surprise or incur late fees/charges against the loan.
Who owns the money in an escrow account?
You own the money. However, the lender controls it to pay your tax and insurance bills. It’s considered a secure place to “hold money” for lender payments but still allow for borrowers access should the mortgage have early payoff.