Escrow 101 – What You Need to Know When Buying a House

If you’re buying a home and are a little confused about how escrow works, don’t worry. You’re not alone. Many homebuyers and homeowners have questions about escrow. To help clear up some of the confusion, we’ve put together a quick guide for you to help explain what escrow is and how it works. 

What is Escrow?

An escrow account is simply an account designed to hold monies for a specific purpose. Homebuying often involves two types of escrow accounts: one before the purchase takes place and one after. 

Escrow Before the Purchase

After putting an offer on a home, sellers like to see what’s called “earnest money.” Earnest money is usually 1 to 2 percent of the purchase price put into an escrow account to show you’re serious about buying the property. 

Once the deal goes through, the earnest money is returned to the buyer who usually puts it toward the down payment on the house. 

It’s important to note here that earnest money may or may not be returned to the buyer if the deal falls through. If you back out of the deal voluntarily, the seller may keep your earnest money. If, however, the deal falls through because an appraisal doesn’t come back high enough or the inspection turns up less-than-acceptable repairs, you will likely get your earnest money back. 

Escrow After the Purchase

The first earnest money escrow account is a short-term account. After you purchase your home, your lender will likely open a long-term escrow account that will be used for the life of your loan. This account will hold the property taxes for your home as well as the homeowner’s insurance premiums so your lender can be sure these bills are paid on time and in full each year. 

When you have an escrow account, your monthly payment will include the mortgage itself, the monthly property tax, and the monthly insurance premium. The total will be divided up and the proper amount to cover taxes and insurance will be deposited into your escrow account. When it comes time to pay these bills, your lender will do it on your behalf. 

Keep in mind that if your property taxes or homeowner’s insurance fluctuate, so will the amount you need to pay into your escrow account. Your lender should notify you of any significant changes to your mortgage payments. 

Refund for Escrow Surplus

There may be times when your lender collects more escrow money than it actually needs to pay your taxes and insurance. In this case, you will receive a refund check for the difference. 

By law, your lender can collect the amount needed to pay your taxes and insurance, plus a cushion of two months’ worth of each, plus $50. So, if your calculated escrow is $7,200, the lender can collect an additional $1,200 and the extra $50 for a total of $8,450. If your property taxes and/or insurance comes in at less than that, your lender will issue a check for the difference. 

Escrow may sound a little confusing and restrictive at first, but it’s nice to have because you don’t have to worry about paying your property taxes and homeowner’s insurance yourself. If you ever have any questions concerning your escrow account, your lender will be happy to answer them.