Unless you’ve been through the home-buying process, the term Escrow probably does not mean much to you. Escrow, as it relates to real estate, is defined as “an account established by a broker under the provisions of the license law for the purpose of holding funds on behalf of the broker’s principal or some other person until the consummation or termination of a transaction.” It’s similar to having a third person hold the money of an informal bet you made with a friend until the wager has been resolved. When you buy a home and take out a mortgage, a third person, an escrow agent, will hold the money until certain things are met (resolved).

How does Escrow work?
When you put money in escrow it is held by the escrow agent who works for both the lender and the borrower. The agent’s role is to carry out the instructions spelled out in the loan documents which typically state the escrow agent is to release funds to pay for property taxes and insurance. The escrow agent will then release these funds as your taxes and insurance premiums come due. Escrow, in the real estate industry, can be involved in anything from multimillion-dollar building projects to the purchase of small, single family home.

When is Escrow used?
When your mortgage closes, your lender will usually require you to open an escrow account to cover property taxes and homeowner’s insurance. You’ll make an initial deposit, followed by payments to the account every month (for convenience and to better ensure that the payments are made on time, usually these are added to your regular mortgage payment).

What is the purpose of Escrow?
The idea of Escrow is to protect the lender by ensuring that you pay your taxes and insurance on time. If you default on your property tax, for example, your county can put a tax lien on the property, which would make it difficult for the lender to sell the property if they ever repossessed it. Or if your property burns down and you’ve neglected to pay the insurance, the lender would be left with no collateral (no property).

How do you benefit from Escrow?
Escrow can benefit borrowers by helping them spread insurance and tax expenses evenly over the year. For example, assume your yearly property taxes are two payments of $1,000 each, and your insurance is $400 annually. If you paid these directly, it would mean three large payments a year ($1000, $1000, and $400); your escrow costs, however, would be a manageable $200 a month. This will allow you to more easily fit these expenses into manageable payments.

How do your Escrow payments work?
Your escrow account will have a built-in cushion so, if you miss a payment, the lender will still be able to pay your accounts on time. However, federal law prohibits lenders from requiring more than two months expenses in escrow. And because your tax and insurance costs may change slightly from year to year, the lender may review and recalculate your escrow payments annually.

Can Escrow be waived?
In most states, the money you place in an escrow account earns no interest for you. For that reason, many borrowers prefer to pay their taxes and insurance directly. Lenders may agree to this if your down payment is more than 20 percent, although some may raise your interest rate slightly to compensate. Some borrowers, however, are required to have them — chiefly borrowers who put less than 20 percent down and those with government-backed mortgages such as those backed by the Federal Housing Administration or Department of Veterans Affairs.

Once you agree to use an escrow account to manage your tax and insurance payments, it is difficult to cancel it, so make sure you fully understand the terms before your mortgage closes. Your real estate agent can answer any questions you have regarding the process so don’t be afraid to ask him…he’s being paid to help you.

This has been Real Estate Rob putting you on the Inside Track to home ownership.