What Is Escrow?

Whether you are a homebuyer or homeowner, establishing and funding an escrow account will likely be part of your homeownership journey. Here’s what you should know about this piece of the mortgage process.

Escrow is an arrangement in which a third party holds and then transfers money or property among different parties.

You are likely to come across escrow in two different contexts: when you are buying a home and while you are paying a mortgage on your home.

What to Know About Escrow as a Homebuyer

When you buy a home, a seller will typically want a good faith deposit, which is a sum you put down with your offer to show you’re serious about buying the home. The good faith deposit will go into an escrow account, where it will stay until closing, when you can apply the funds toward your down payment or closing costs.

In addition, most lenders will require you to pay in advance for some items that will be due after closing, generally including homeowners insurance premiums and property taxes. These prepaid funds will go into an escrow account.

To determine whether your lender requires an escrow account, look at the first page of your loan estimate. It will indicate whether an escrow account is required and estimates the amount of your monthly escrow payment.

Your loan estimate will also include information about an initial deposit for your escrow account, which you will pay at closing. The initial deposit generally includes two months of homeowners insurance premiums and property taxes.

What to Know About Escrow as a Homeowner

Once you start making your monthly mortgage payments, in addition to paying principal and interest, you may also be making escrow payments. Many lenders require an escrow account be established under the terms of your mortgage.

Your escrow payments are designed to cover a portion of your annual costs for property taxes and insurance premiums, such as homeowners insurance. Your escrow payment goes to your lender, who deposits the money into an escrow account. The lender uses the money in the escrow account to pay for the items on your behalf when they are due each year.

Regularly scheduled escrow payments are a good option for many homeowners because they eliminate the surprise of a large annual payment for those expenses.

Your monthly escrow payments are generally designed to cover a portion of the estimated annual costs for the following:

• Property taxes. Your mortgage payment will typically include one-twelfth of the estimated annual real estate taxes on the home you purchased. These payments are put in an escrow account, and your lender will use the funds to pay the taxes on your behalf when they’re due.
• Homeowners insurance. Your mortgage payment will include one-twelfth of your annual homeowners insurance premium. Just like your taxes, the money will go into an escrow account and your lender will use it to pay your homeowners insurance.
• Mortgage insurance. If your down payment is less than 20%, your lender will require private mortgage insurance. As with your taxes and homeowners insurance, one-twelfth of the annual premium will be included in your monthly payment and placed into an escrow account.

Check your year-end escrow statement carefully to make sure your bills are being paid and there are no mistakes. If you have questions or find a problem, contact your lender immediately. These payments are ultimately your responsibility.

You should also talk to your lender about your escrow options. You may be able to cancel your escrow payments once you have built up at least 20% equity in your home and are current on your payments. However, remember that you'll then be responsible for paying your taxes and insurance directly in full and on time.