Owning and Renting Property

All About Escrow

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“Escrow” is a term you hear a lot when you’re buying a house. You might nod your head in agreement when your mortgage broker talks about your escrow account and putting money in escrow while silently wondering, “where am I putting what?”

Let’s break down what exactly escrow accounts are so you can master this tricky real estate term.

What is an escrow account?

In real estate terms, an escrow account (also known as an “impound account”) works like a holding tank where funds or proceeds are kept by an impartial third party for a certain length of time. There are two types of escrow accounts that may be used when you buy or sell a home:

  • An escrow account used before or during the time of closing: This is when an escrow officer — usually an attorney or title company representative — holds all the important documents and deposits while the buyer and seller work out the details. The escrow office makes sure the closing goes smoothly and everyone gets paid what they’re owed. After the closing, the escrow agent records the deed and title transfer that make the home officially yours.

For example, when you make an offer on a home, you typically put down earnest money or a “good faith” deposit (usually in the form of a bank check) to show your intentions to purchase the property. That deposit is placed in an escrow account, which means it won’t go directly to the seller but rather is being held by an impartial third party while you and the seller negotiate a contract and close the deal.

  • An ongoing escrow account: When you purchase a new home, your mortgage lender typically sets up an escrow account to pay obligations, such as property taxes and home insurance premiums, on your behalf. Here’s how it works: you pay monthly installments for property taxes and home insurance along with your monthly mortgage payment. Then your mortgage servicer will deposit these monthly installments into the escrow account. Your servicer uses the funds to pay your bills when they come due, typically once or twice per year.

At the end of the year, the lender adjusts your monthly escrow amount based on the actual property tax and home insurance bills. If you were short, you’ll generally be allowed to spread the difference out over the coming year. If you paid in too much, the lender will refund your money.

What you need to know about escrow accounts

Many lenders require that you pay your property taxes and home insurance using an escrow account, so they can make sure that the bill gets paid. Sometimes, escrow accounts may also be required by law. However, even if your lender does not require an escrow account, consider requesting one voluntarily. An escrow account makes it easier to budget for your large property-related bills by paying small amounts with each mortgage payment. That way you don’t have to scramble to pay a large property tax bill or insurance premium when it comes due.

Also note that the federal Real Estate Settlement Procedures Act limits the amount of money lenders can require to be held in an escrow account. So if you feel the amount you’re paying into the escrow account is too much or you’re having difficulty breaking down the different amounts going into the account, contact your mortgage lender.

Also, if you have additional questions about an escrow account and how it works, it’s not a bad idea to enlist the services of an attorney who focuses on real estate law for guidance.

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