What is an Escrow Account and How Does It Work?
If you’re not familiar with all of the terms and acronyms that get tossed around during the home buying process, there may be times when you feel like your real estate agent and mortgage lender are speaking a foreign language. Don’t worry, we’re here to help you learn the lingo!
When in you’re in the process of buying a new home, one of the common terms you’ll hear is “mortgage escrow.” This is different from the real estate transaction escrow account that is used to store the funds you will use to purchase your new home.
So, what is an escrow account and how does it work?
A mortgage escrow account is set up by your mortgage lender prior to closing and will be used to collect and store additional funds needed to pay your annual property taxes and homeowners insurance premiums.
These funds are divided equally over the course of 12 months and collected as part of your monthly mortgage payment. For example, if the total amount owed annually for property taxes and homeowners insurance is $4,500, your monthly mortgage payment will include an additional $375 to account for those costs. These funds are then held and paid upon due. (Click here to learn how your monthly mortgage payment is determined)
Advantages of having an escrow account
In a way, having an escrow account is a lot like having a separate savings account that’s set up specifically to manage the additional costs associated with homeownership. By rolling the cost of property taxes and homeowners insurance into your monthly mortgage payment, you eliminate the need to budget for these bills on your own and ensure that they will be paid on time and in full.
Without an escrow account, you would be responsible for setting aside money for your property taxes and homeowners insurance on your own. It’s a lot easier to come up with $375 each month (and lock it away somewhere it can’t be accessed) than it is to come up with $4,500 at once. Plus, you don’t have to worry about remembering when payments are due because everything is handled automatically and paid for you.
Is an escrow account required?
When you sign your closing papers, you assume the responsibility of paying your property taxes and homeowners insurance on time. To mitigate the risk of having a borrower fall behind on these payments, most mortgage lenders require borrowers to set up an escrow account if they are a first-time buyer, have a down payment less than 20 percent or have a mortgage program that requires escrow.
However, the peace of mind that comes from establishing an escrow account (especially for those who encounter challenges saving) outweighs the short-term benefits of eliminating the cost of property taxes and homeowners insurance from your monthly mortgage payment.
As you can see, an escrow account can help you manage the additional costs associated with homeownership and provide you with peace of mind knowing that your property taxes and homeowners insurance are automatically taken care of.
Now that you know what an escrow account is and how it works, you’ll have a better understanding of how it will impact your monthly mortgage payment and home buying decisions.
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