What is escrow? Meaning, function and benefits
When you buy a home, you may hear your real estate agent or lender mention the term “escrow” while discussing the transaction process. Having money in escrow means you agree to give a certain dollar amount to a neutral third party who holds onto it until the contractual obligations of both parties are met.
It’s important to note there are two different types of escrow accounts that may be used during the homebuying process: pre-closing and post-closing. We’ll be reviewing the differences below.
What does escrow mean?
As mentioned, an escrow agent acts as a neutral third party in a real estate transaction. Their job is to hold onto money during the transaction before agreed-upon requests are completed on both sides.
In the case of buying or selling a home, neither the buyer nor the seller has access to said money. This is usually done by putting it into a separate bank account, usually referred to as an escrow account. Once all conditions are met in the transaction, escrow will make the funds available to close the deal.
What does escrow mean on a house?
When you make an offer on a home, you will write an earnest money check, which represents the buyer's good faith to the seller. This earnest money check is placed in a pre-closing homebuyers escrow account until you and the seller close the deal. This practice allows you more time to work out any additional financing, inspections and approvals needed for the rest of the transaction.
If you successfully close on the home, the earnest money goes toward your down payment or closing costs and is paid directly to the seller or lender. If the deal doesn’t go through, the money will either be returned to you or go to the seller, depending on the terms of your contract.
Why do you need to put money into an escrow account?
Real estate transactions can be stressful for the buyer and the seller. While most transactions occur with everyone acting in good faith, it’s easy for mistakes to be made.
As a buyer, if you wrote a check directly to the seller, you risk a seller cashing out your earnest money payment before closing. Or, as a seller, if a buyer were to withdraw their earnest money and pull out of a sale, you may miss the opportunity to sell your home without any guarantee of collateral from a buyer.
This is why escrow is key—it ensures both buyers and sellers are protected during the homebuying journey because it prevents either party from handing money over prematurely. It also helps facilitate the smooth transfer of funds to the seller once closing is completed.
What is an escrow payment for homeowners?
When you buy a house, your lender may set up a post-closing escrow account for you. This is done because, while you may make monthly mortgage payments, some parts of your payment may also go toward property taxes and insurance premiums, which are paid quarterly or yearly.
To help ensure everyone is paid on time and in full, your lender or mortgage servicer will set up a mortgage escrow process. They first project your yearly and monthly payments based on taxes, your loan amount and your insurance policy. This calculation establishes how much money should be kept in your account. Then, when you make your monthly mortgage payments, the escrow account serves as a holding place for your property tax payments and homeowners insurance premiums.
Your lender is required to keep you apprised of any escrow shortages or surpluses.escrow-accounts They will usually notify you on an annual basis and either adjust your monthly payment to make up for any shortages or distribute a refund if you have a surplus in your escrow account.
What are the benefits of homeowners escrow payments?
Having an escrow account as a homeowner comes with a few advantages, such as:
- Escrow accounts can help prevent disputes between buyers and lenders.
- An account can ensure your property taxes and/or homeowners insurance payments are made on time.
- The lender assumes initial responsibility for making your property tax and/or insurance payments—so even if they go up, it may be covered by your lender. Although, you’ll still need to repay the difference in the future.
What are the drawbacks of homeowners escrow payments?
There are also a few disadvantages:
- The buyer cannot use the funds in escrow for other purposes, even if they’re needed.
- A larger upfront payment may be needed to set up an account so the first couple of month’s expenses are covered.
- Automatic payments may inhibit short-term savings or investments.
In summary
By providing a secure, third party to hold your money, escrow means that homebuyers and sellers are protected and sales can go through with less hiccups. As a homeowner, putting money into an escrow account helps ensure your mortgage payment is distributed at the right time to all the necessary parties. In both cases, escrow can help make homeownership less stressful for everyone.
Now that you know what escrow is, you’re one step closer to starting the homebuying process. The next step? Apply for a mortgage today, and talk with a Home Lending Expert.
What does escrow mean: FAQs
Is it good to be in escrow?
Having money in an escrow account is neither good nor bad. It’s simply part of the homebuying process. However, if being in escrow puts you closer to your dream of homeownership, then it’s a good thing.
Who owns the money in an escrow account?
Technically, the money in an escrow account is still owned by the person who deposited it. The escrow account simply serves as a safe place for the money to be held until all parties are in agreement that the funds can be withdrawn.
Do you get escrow money back?
If you overpay into an escrow account and generate a surplus, you may be able to get your money back. You may also be able to get back some of the funds in escrow if you pay off your mortgage early or refinance. Prior to closing, If a contingent home sale falls through, you may be able to recover some or all of the earnest money you deposited into your escrow account. This will depend on the terms of your home purchase offer and the types of mortgage contingencies included.
