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What Is an Escrow Account and How Does It Work?

Escrow appears to be a made-up term that someone may use to cheat in Scrabble. But we assure you, it’s true!

You don’t hear much about escrow until you’re in the process of purchasing a home. Maybe you’ve seen a “For Sale” sign with the words “In Escrow” at the top and wondered, “What the earth does it mean?”.

Let’s take a deeper look at escrow to learn more about it and why it’s essential when buying or selling a house.

What Exactly Is Escrow?

An escrow is a legal arrangement in which a third party holds significant sums of money or property for a period of time until a certain condition is satisfied (such as the fulfillment of a purchase agreement).

It is used in real estate transactions to safeguard both the buyer and seller during the home-buying process. In addition, an escrow account will keep funds for taxes and homeowner’s insurance during the length of the mortgage. Consider escrow to be similar to a football referee. They take no sides and ensure that everyone follows the rules until the game is done. However, real estate is the name of the game here.

Being in escrow means different things depending on whether you’re a property buyer or seller:

  • As a buyer, you agree to deposit a part of the purchase money into escrow for safety.
  • As a seller, you agree to remove the property from the market while it is under contract and make it available for inspections.

Escrow aims to guarantee a fair and smooth real estate transaction from start to finish. Of course, escrow accounts can also be used for other purposes, such as online retail purchases (where the escrow service holds onto the money from the buyer until confirmation that the goods have been received). But we’re talking only about real estate escrow for the very moment.

Escrow Account Types: Remember, you’ll mainly need escrow to store money while making the largest purchase of your life—a house! However, you will also use it after closing on your property. So let’s go over both options.

 Escrow Account for Home Purchases

When you discover your dream house and the seller accepts your offer, you’ll most likely use an escrow bank account. This is how it works:

  • Choose an escrow agent. Your real estate agent will almost certainly recommend an escrow agent on whom both you and the seller can agree. This escrow agent might be a licensed title agent, a real estate attorney, or a mortgage loan officer.
  • Make a down payment. You’ll be requested to make an earnest money deposit, which is a minor percentage of the home’s sale price, that you’ll make payment to the escrow provider. They will keep your money until the deal is completed.

Earnest money functions similarly to a security deposit in that it demonstrates to the seller that you are serious about purchasing their home. In exchange, they promise to remove the house from the market, make it available for inspections, and do any agreed-upon repairs or give disclosures to help the transaction go through.

When it comes time for closing, the earnest money will be deducted from the total you owe the seller and used to closing costs.

If the seller fails to complete an agreed-upon repair before the closing date, money might be kept in escrow to pay the expense to you. But what happens if the agreement falls through? Don’t worry. Your earnest money will be returned minus a minor cancellation charge.

Mortgage Payment Escrow Account

Most mortgage lenders will require you to maintain an ongoing escrow account for taxes and insurance even after you buy a home.

This escrow account will be in your name, with funds paid in by you, and will be accessed by your mortgage lender. This is how it works:

  • Create an account. After you’ve closed on your home, your mortgage company will set up your escrow account.
  • Make your payments. Then, as part of your monthly mortgage payment, you contribute to it.

A homeowner escrow account isn’t the most exciting thing in the world because its primary intention is to provide a central place for you to pay expenses such as property insurance and taxes.

How Does It Work?
Just imagine the closing day – the final day of your home purchase. You’re happy. The champagne is cooled down, and you’re signing documents at your real estate attorney’s office. This is when you’ll receive a breakdown of your monthly mortgage payment from the lender.

Consider the acronym “PITI” to help you understand what’s included in your monthly mortgage payment. It stands for Principal Interest Taxes Insurance.

Taxes and insurance are components of your monthly payment that will be deposited into your escrow account and held by your lender in order to pay property taxes and home insurance each year.

Mortgage lenders prefer that you have an escrow account so they don’t have to worry about you falling behind on these important payments. Finally, you don’t want to lose your home, and they don’t want to lose the money they just loaned you!

And as previously stated, an escrow account is beneficial to you because it relieves you of the burden of ensuring that your property taxes and home insurance are paid on time each year. That’s what the escrow account is for!

How Often Should You Pay Into Escrow?

You will make monthly payments to your escrow account for as long as you have a mortgage. Remember that your escrow account receives a part of your mortgage payment (property taxes and home insurance).

When you finally pay off your mortgage and own your home outright, you’ll still have to pay property taxes and home insurance. However, now that your mortgage has been paid off, you will be responsible for making those payments directly to your local government and insurance provider.

Is Escrow a Good Thing or Bad?

Having an escrow account is not a bad thing. It’s just like having forced savings account for your taxes and insurance bills. You won’t have to worry about forgetting to budget for those expenses this way. Instead, your lender will handle them for you and make sure they are paid on time.

The only major drawback of using escrow is if you prefer to handle your taxes and insurance payments. You will lose some control over this because your funds will be held in an escrow account and managed by your lender.

Escrow is an essential component of the home-buying process. It protects both buyers and sellers during home sales and provides a simple way for you to pay your insurance and taxes.

If you’re ready to start the home-buying process, contact LBC Mortgage now.

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