If you're in the midst of purchasing a home, you'll likely hear about escrow, which is an integral component of the home-buying process. Escrow is a common legal arrangement that's made during the sale of a home that can also transfer over to your ownership of a home depending on how your lender treats the account. Even though escrow accounts may seem difficult to understand, escrow accounts are relatively simple and straightforward. Before you go through the process of buying a home, read further to gain a better understanding of what an escrow accounts is and how it affects you when purchasing a home.

What Is an Escrow Account?

Escrow is a kind of legal arrangement that occurs when a third party holds substantial sums of money until specific conditions have been met. When buying a home, you will meet these conditions when the sale of the home is completed. When used correctly, escrow provides a certain level of protection to the buyer and seller alike.

If an escrow account is used during the purchase of a home, it can protect the earnest money you put down while also holding your down payment. Once you've purchased the home, the escrow account will consist of funds for homeowners insurance and property taxes. However, the property taxes are an estimate based on the value of your home. If the estimate is too high, you'll receive an escrow refund. A low estimate means that you'll need to cover the difference at the end of the year.

What are the Different Types of Escrow Accounts?

To understand how an escrow account works, you must first know about the various types of escrow accounts. When it comes to real estate, there are two types of escrow accounts that you should be aware of, the most important of which is set up when you're buying a home. By placing the funds for buying the home into an escrow account until the transaction is completed, the buyer has time to perform their due diligence. An example of due diligence that an escrow account applies to is the inspection that must occur after the seller accepts the buyer's offer.

The money that the buyer provides to purchase the home can be held in an escrow account until the inspection occurs. While the funds are held in an escrow account, the seller can be confident that the money for purchasing the home is actually available while they complete the inspection. Once every condition pertaining to the sale of the home is wholly satisfied, the money that's being held in the escrow account will be transferred directly to the seller. This process usually occurs on the closing date.

It's also possible for an escrow account to be created right after the closing process takes place. Your lender might choose to use the same escrow account once the title of the property has been transferred to you. Escrow accounts that are made after closing are designed to hold property tax payments and homeowners insurance payments until the payments are due.

A small amount of your monthly mortgage payment will be placed into your escrow account every month to account for the aforementioned payments. By placing this money into an escrow account on a monthly basis, you won't need to worry about your property tax bills or insurance premiums at the end of the year. Escrow accounts can also be made to hold stocks and to protect money during online sales.

Do I Need an Escrow Account?

An escrow account is almost always used during the closing process and will be opened by your lender. The account provides you and the seller with protection, which ensures that the closing process can continue without issue. Once the closing date occurs, the escrow account that was made at the beginning of the process can either be closed or kept open for future insurance and property tax payments.

If you're wondering about the need for an escrow account while you're a homeowner, the answer is that the account isn't a necessity. Instead, it's up to you to determine which option is best for your situation. With an escrow account, your insurance premium payments and tax payments will be included as part of your monthly mortgage bill. These payments will then be transferred to your escrow account, which is where they will be held until they are paid to your insurance provider and the IRS.

While many homeowners use an escrow account to handle these payments, you may benefit from taking care of the payments yourself. If you don't use an escrow account, your monthly mortgage payments will be lower. However, you'll still need to save for your insurance and tax payments, which will need to be paid once per year. As such, the option you choose largely comes down to personal preference.

Keep in mind that the type of loan you choose can dictate whether an escrow account is a requirement or simply an option. If you apply for a VA loan, the only way to opt out of an escrow account is by having great credit and by making a down payment of at least 10%. As for conventional loans, escrow accounts are required unless you make a high down payment of at least 20%. In the event that you apply for an FHA loan, every borrower must have an escrow account and will be unable to opt out of one.

If you don't want to have an escrow account, make sure that you take the escrow loan requirements into account before you choose the type of loan you want. There's also a possibility that you will be able to keep some of your expenses in escrow while others are held out of it. Some lenders provide borrowers with the opportunity to keep their property taxes in an escrow account but not their homeowners insurance premiums.

Who Handles My Escrow Account?

The only rule regarding who can handle an escrow account is that the account must be handled by a third party. This third party can be a mortgage servicer, an escrow company, or an escrow agent.

Escrow Companies and Agents

When you're purchasing a home, your escrow account can be managed by an escrow company or agent. The escrow company that manages your account is usually the title company. Along with your deposit, the escrow company can manage the property deed as well as other pertinent documents for the sale of the home. Since the escrow company or agent is working on behalf of both the seller and buyer, their total fee is usually split between the seller and buyer.

Mortgage Servicers

A mortgage servicer is someone who's responsible for managing your entire mortgage from the moment the closing occurs until you've fully paid off your loan. These individuals will collect your monthly mortgage payment, manage your escrow account, and maintain records of all of the payments you've made. In many cases, your mortgage servicer will be the same as your lender. However, there's also a possibility that your lender will sell the servicing rights for your loan.

Keep in mind that not every mortgage servicer provides the same level of quality. Some will also charge higher fees than others. In the event that a mortgage servicer is handling your escrow account, you won't need to do much. The mortgage servicer will handle all payments of insurance bills and tax bills.

Pros and Cons of an Escrow Account

While an escrow account can be highly useful, you should be aware of all of the pros and cons before you go forward with buying a home. The primary benefit of an escrow account is that your money will be protected while the real estate transaction is ongoing. Let's say that a purchase agreement is in place but the inspection shows that the damage to the home is more substantial than you initially believed.

If you don't have an escrow account and have instead provided your down payment directly to the seller, they might not return the money you gave. Having an escrow account allows you to avoid this problem altogether. Escrow accounts are also advantageous for the homeowner as well as the lender. When you're a homeowner, you won't need to focus on paying your property taxes and insurance premiums in a lump sum. As for lenders, escrow accounts are advantageous because they make sure that you pay your property taxes and insurance premiums on time.

Despite the many benefits that come with an escrow account, there are also a few issues that you should be aware of. As a homeowner, your mortgage payments will invariably be higher, which can be frustrating when you're trying to set a strict budget on your monthly expenses. As mentioned previously, the tax payments you make are only estimates. If the estimate is too low, this means that you wouldn't have enough money in your escrow account at the end of the year. In this situation, you would need to make up the difference from your own savings.

Even though escrow is one of the more confusing terms you'll hear when buying a home, the truth is that an escrow account is nothing more than a bank account that temporarily holds funds. Now that you're aware of what this term means and how it affects your position as a buyer and homeowner, you should be more confident during the home buying process

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