Escrow is a legally-binding agreement in which an impartial third party maintains funds in an account that will later be paid to the seller on behalf of the buyer. This demonstrates a commitment to a future transaction while the money is overseen by an unbiased person or entity; the funds are not accessible by either of the people involved in the purchase.
In the field of real estate and mortgages, there are two different types of escrow accounts.
1. 30-Day Escrow
When you make an offer on a home, the seller wants to know you’re serious about buying their home so you’ll be asked to provide earnest money that will be deposited into an escrow account. The money remains there until your loan is closed and all the papers have been signed.
The amount of earnest money varies depending on the current housing market, state regulations and other factors. In general, though, you can expect to provide 1-2% of the total home price for earnest money. The title company, real estate broker or other fiduciary will hold the money in escrow.
In competitive markets where there are more buyers than homes, you may want to consider a larger earnest money amount in order to entice the buyer to take your offer.
Generally, if the deal falls through, your earnest money will be returned to you minus a small administrative fee. Don’t give your escrow check directly to the seller, no matter how nice they seem. If something goes wrong, it could be difficult to get your money back.
2. Mortgage/Lenders Escrow
Depending on your loan type (more on that below), you may be required to maintain an escrow account to cover real estate taxes (also called property taxes), homeowner insurance and mortgage insurance
(PMI) if required. Your monthly mortgage payment will include funds to cover the loan’s principal, its interest, taxes and insurance (often referred to as PITI). At the closing you’ll receive important documentation
, including details about your escrow account.
The mortgage lender holds the tax and insurance portions of your monthly payment in escrow until they are due. They send payment directly to your city’s taxing body and your insurance provider(s). Each year, your lender will run and send you an escrow analysis to determine if the amount of money collected over the previous 12 months for tax and insurance is appropriate—if not, your monthly payment will be adjusted up or down.
Some homebuyers are exempt from the escrow requirement, but have the option to include it. Here are a few of the most common reasons why escrow may—or may not—be mandatory. However, you should ask your Mortgage Loan Originator for details on your specific loan requirements:
- Federal Housing Administration (FHA): Required
- Veterans Administration (VA): Not always required, but is sometimes included to verify that the home remains insured
- Conventional Loans with at Least a 20% Down Payment: Not usually required
Even if escrow isn’t mandatory for your loan, if you’re concerned about making two large tax payments and two large homeowner insurance payments each year, you may want to consider establishing an escrow account with your lender. This will allow you to automatically accumulate money for these expenses as part of your monthly mortgage payment.
Escrow can seem like an intimidating topic, so we hope this overview provided you with a good summary of escrow. If you have any questions, contact us today!
Mar 26, 2019