Escrow: Definition

An escrow is a legal agreement where a third party temporarily keeps a large amount of money or property until a particular condition (like a purchase agreement) is fulfilled. It is mandatory in real estate transactions to safeguard both the seller and buyer throughout the property buying process. During the mortgage tenure, an escrow account will keep the fund, for the homeowner’s insurance and tax payments.

Escrow Accounts: Categories

In real estate transactions, escrow is usually used for two reasons:

To ensure the buyer’s faith deposit goes to the right party according to the agreement.

To keep the fund for the homeowner’s taxes and insurance.

Since it serves two different purposes, it can be categorized into two kinds of accounts. One is for purchasing properties, second is applicable throughout the mortgage term.

Escrow Accounts for Purchasing Property

While buying an estate, your purchase contract will generally include a good faith deposit which implies that you are serious about purchasing the estate. If the agreement gets canceled because of the buyer’s fault, the seller will receive the money. If the purchase is successful, the deposit is adjusted against the buyer’s down payment. If the money is held in escrow after the property is sold, it is called an escrow holdback. Once all the conditions are met properly, the right party will get to have the money.

Escrow Account for Insurance and Taxes

After purchasing the property, your mortgage provider may create an escrow account for paying your insurance and taxes. Once closed, the mortgage servicer or lender can take a part of your monthly mortgage payment and keep it in the escrow till your insurance and taxes are in arrears.

The fund required for escrow can fluctuate, as your insurance premium amount and tax bill change every year.  Your lender will determine your next escrow payment based on the payments made last year. To ensure sufficient balance in the escrow, the lender may ask for a couple of months’ worth of extra amount in your escrow account. The service or lender will assess your escrow account annually, and if they conclude that they have over-collected, they will give you an escrow refund. Again, if they determine that they have collected insufficient funds, you need to cover the difference amount. Either you can go for a one-time payment or add the amount to your periodic mortgage payment.