What is Escrow and How Does It Work?

​When clients buy a home and purchase the needed homeowners insurance, they might hear the word escrow thrown around. Let's look at what escrow is, how it is used, and how it can benefit you as a home buyer or homeowner.

What is Escrow?

Escrow is a legal agreement in which a third party temporarily holds money or property until a particular condition has been met, such as the fulfillment of a purchase agreement. It is used to protect the buyer and seller throughout the home buying process. Also, throughout the term of a mortgage, an escrow account will hold funds for taxes and homeowner's insurance. Escrow accounts may be handled by a variety of third parties, including an escrow company, an escrow agent, or a mortgage service provider. 

How is Escrow Used?

An escrow account is used in two different ways: to protect the buyer's good faith deposit and to hold funds for payment of taxes and insurance.

In a home purchase, an escrow account is used to protect the buyer's good faith deposit (also known as earnest money) until the fulfillment of the terms of a purchase contract. This account shows that you are serious about buying the home. The earnest money is held in an escrow account until closing, at which time that money will be applied to the down payment for the buyer. If the contract falls through due to the fault of the buyer, the seller usually gets to keep the earnest money. If the home purchase is successful, the earnest money will be applied to the down payment. Sometimes, funds are held in escrow past the completion of the sale of the home until certain conditions are met by buyer and seller. 

An escrow account is also used to hold funds for payment of taxes and insurance. After closing, your mortgage service provider takes a portion of your monthly mortgage payment and sets it aside in the escrow account until your tax and insurance bills are due. These bills can change from year to year, and your mortgage provider will determine each year how much needs to be held in escrow to cover these bills.

Benefits for a Home Buyer or Homeowner

For a home buyer, an escrow account protects your deposit during the purchase of your home. If the sale falls through and you paid the seller directly, you might not get your money back at all from the seller. When the money is being held by a third party, your money will be returned according to the contract.

For a homeowner, an escrow account makes it easier for you to pay your taxes and homeowners insurance for the entire year. Instead of paying a lump sum for those bills, you are paying for them throughout the year from the escrow account, which can make the payments more manageable. 

Disadvantages of an Escrow Account

The main disadvantages of an escrow account include higher monthly mortgage payments since it includes your taxes and insurance, and occasional incorrect estimates of what needs to be held in escrow, resulting in fluctuating monthly mortgage payments.

Contact us today if you would like a homeowners quote or have any questions about your homeowners insurance.