When you purchase a home it is common for your real estate agent to mention escrow. Often, your earnest money will end up going towards your escrow. But what does this really mean?
When your money is “in escrow” it means it is with a neutral third party that holds it until a specific condition has been met. It acts as a bank account of sorts that you can put money into in order to make payments later. Typically, escrow is 1%-2% of the purchase price of your home.
Buyers and sellers will use an escrow account during the home sale process to secure the buyer’s earnest money deposit. The earnest money deposit is a sign that buyers are serious about a purchase and have the funds to back up their offer. If a buyer does not follow through with the purchase, the seller can keep the funds. It also ensures that the seller follows through with any contingencies for the sale. The title transfer of a home often takes place via an escrow or title company.
After the purchase of a home, a homeowner will use escrow to hold some money for insurance, taxes, and other fees. Many mortgage servicers will require homeowners to pay property taxes and home insurance through an escrow account. This protects the buyer and the mortgage servicer. Money will be deposited into the escrow account out of your monthly mortgage payments.
There are some pros to an escrow account, like:
Protection: Escrow protects your earnest money deposit even if the sale doesn’t work out.
Your Lender Pays on Your Behalf: With the escrow deposits coming out of your monthly mortgage payments, you don’t have to make tax or insurance payments yourself. You also won't have the stress of coming up with a lump sum whenever payments are due.
Timely Payments: Because your mortgage servicer makes payments on your behalf, you do not have to worry about making these payments on time. As long as your mortgage account is current, your mortgage servicer will be able to pay on time.
There are, however, some potential problems that could arise if you use escrow to pay your property taxes and homeowners insurance bills.
Escrow Shortage: The amount your mortgage servicer calculates to put into your escrow account is a guess based on property taxes and insurance premiums. If taxes or insurance premiums go up, your escrow could be lacking the funds to make a full payment. In this case, you will fall short and will have to make up the difference.
Higher Mortgage Payments: Because you are paying for your taxes, insurance and monthly mortgage payment all in one, your monthly payment will be higher than it otherwise would be if you were paying insurance and taxes separately.
Upfront Payment: Some mortgage servicers require you to put two or more months of funds for property taxes and insurance in an escrow account upfront. It can be difficult to come up with these funds after recently purchasing a home and paying closing costs.
Most mortgage servicers and lenders will require you to put money into an escrow account and it can be difficult to remove escrow from your mortgage. If you want to remove escrow from your account, there may be certain qualifying measures you can meet to do so. A lender may ask you to show you can make your payments on time for a period of time. You may have to provide proof of payment to your servicer.
Escrow can protect you, the seller, and your lender. If you have real estate goals in mind, Veitengruber Law can help demystify the real estate process. We offer contract review and can help you achieve your real estate dreams while making smart financial decisions throughout the process.