Understanding Escrow Accounts

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When you’re buying a home, you’ll hear a lot of terms thrown around, including escrow, or escrow accounts. Escrow accounts protect buyers, sellers, and lenders, and serve one of two purposes:

  • To hold an earnest money or good faith deposit when you first purchase a home, or
  • To pay property taxes and insurance premiums

Homebuying Escrow Account

When you buy a home, you may put down an earnest money or good faith deposit (this is like an early down payment showing the seller you’re serious about buying the home), and your real estate agent will arrange for an escrow account. This account will hold funds from both you and the seller until any of the following occur.

  • You fulfill the terms of the contract: If you fulfill the contract terms, the escrow funds will be released as a part of your down payment. Whatever you put down for earnest money will reduce what you bring to the closing for the down payment.
  • You break the contract: If you back out of the sale for a reason not in the contract, you could give up your escrow funds. The seller has rights to the funds because you didn’t follow through on the agreement. It’s like compensation for taking the home off the market.

Escrow for Taxes and Insurance

When you have a mortgage, you might be required to (or want to) set up an escrow account to pay for your real estate taxes and home insurance payments. If you escrow your taxes and insurance, your mortgage payment will consist of principal and interest plus taxes and insurance payments for the year. The escrow portion of your payment gets set aside and when the time comes to pay the bill, the lender will pay it for you with the funds set aside from your payments.

Your lender will conduct an escrow analysis annually to determine if they are collecting enough or too much money for your escrow account. If you have a surplus, they’ll refund you the difference. But if you have a shortage, they’ll expect you to pay the difference.

This covers the basics. Still want to learn more? Take a deeper dive via Investopedia, and the Consumer Financial Protection Bureau.

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