In real estate transactions, unfamiliar terms can throw off a homebuyer or seller. Escrow is a term you may have heard before, especially when buying or selling a home. But what is escrow? When it comes to mortgages, escrows can be a few different things.
How Escrow Works in the Mortgage Process
Types Of Accounts
There are two different types of accounts used at different stages in the mortgage process.
- An account used to hold earnest money. This happens when buying a home and is typically managed by a title company or real estate company.
- An account used to pay for homeowners insurance, property taxes, and mortgage insurance. This happens after taking ownership of a home and is typically managed by a servicer or mortgage lender.
- The third type of escrow is for repairs. There are times money is held by the title company if there are repairs done after closing. In Minnesota, if there is a repair for exterior work in the winter, money is usually held in an escrow account by the title company until the work is complete.
For Homebuyers
Once a seller accepts an offer on a home, an escrow account is usually established. The homebuyer puts down a certain amount of earnest money to show the seller they are serious about purchasing the property. This is typically due within 72 hours of the offer being accepted.
The amount of earnest money – also known as a good faith deposit – can vary. Typically, a buyer will put down 1% to 2% of the purchase price of the home. If the market is competitive, a real estate agent may guide the buyer to put down a larger percentage. This is common in an instance where multiple offers are being made on the same property or in a popular neighborhood.
Typically, the earnest money is held in an escrow account managed by a title company, real estate company, attorney, or bank. What happens with the escrow payment can vary depending on the scenario.
Sometimes, a buyer has to back out of a transaction before the home purchase goes through. The seller may be given the earnest money to help cover the expense of having to re-list the home.
Other times, the deal may fall through due to something coming up during a home inspection. In that case, the buyer may be given the earnest money back.
If the home being purchased is new construction, escrow money will be held until the final signoff on the construction work.
Once the transaction does go through successfully, the earnest money will be used toward the buyer’s down payment.
For Homeowners
Once a home has been purchased, a new kind of escrow account is created. This account is set up to hold funds for certain tax and insurance payments related to the property.
Depending on the amount of down payment put down, the mortgage lender may require the borrower to set up a mortgage escrow account as part of the mortgage agreement. The funds in the mortgage escrow account are used to ensure certain expenses are paid for and paid on time. These may include homeowners insurance, property taxes, and mortgage insurance.
To set up the account, the lender will calculate the total expenses that must be paid for the year. The lender will divide this amount by 12 and add it to the existing monthly mortgage payment. This is known as an escrow payment and is held by the mortgage company. In addition, your lender will normally require money upfront to help jump-start the escrow account along with a cushion amount.
Each month, when the mortgage payment is made, a portion of the total payment made is deposited into the escrow account. The mortgage lender uses the funds in this escrow account to pay for property taxes and insurance premiums when they’re due. This helps ensure that these expenses are paid promptly and that the property remains protected.
Homeowners Insurance
Homeowners insurance is property insurance that protects your home from losses and damages. It includes personal property insurance that covers assets, belongings, and liability coverage against home accidents. A home insurance policy payment is in the monthly cost of the homeowner’s mortgage when escrowed. Therefore, to protect your new home, homeowners insurance is essential.
Mortgage Insurance
Mortgage insurance is typically required for borrowers who make a down payment of less than 20% when purchasing a home. This insurance protects the mortgage lender if a borrower fails to make timely payments.
What Doesn’t Escrow Cover?
Escrow services do not cover all expenses related to owning a new home. The homeowner will need to budget and manage the payment of their utility bills, homeowners association fees, or other home services.
If you have questions regarding your escrow account, reach out to your loan officer. Most mortgage companies will analyze the escrow account once a year as property taxes and insurance can change. They will send you an escrow analysis and show how your mortgage payment may change based on the new tax and insurance bills.
Leslie Vanderwerf, NMLS ID#335509, CrossCountry Mortgage LLC, An Equal Housing Lender, NMLS#3029 – Email – Website
