If you are in the process of buying a home, “escrow” is probably a term you have encountered. The point of escrow, during a home purchase, is to make sure that such a large transaction goes through.

Escrow is an arrangement in which a third party receives the money for the transaction from the buyer and then disburses it to the seller. The money held in the escrow account accomplishes two things:

Escrow is about more than just managing a home purchase transaction. It can also be used to ensure that property taxes and home insurance are paid.

Property Taxes and Home Insurance through Escrow

An escrow account is established separately and deposits are made to pay property tax and home insurance. This money is usually collected by the mortgage lender at the same time as the principal and interest payments. One payment is made by the borrower and the funds are divided up, with some going to the mortgage account and the money for taxes and insurance going to the escrow account.

The escrow agent is charged with making sure that the money goes where it should. These accounts are often required by mortgage lenders who want to make sure that property taxes and home insurance are paid. This reduces the risk to lenders that the failure to pay property tax will result in a lien that can lead to a borrower’s default.

If property taxes or home insurance costs go down during the year, the escrow account will have extra money in it and it is usually refunded to the borrower. However, if property taxes or insurance costs rise, the borrower might be required to pay in the difference.

It is worth noting that for conventional loans a borrower might have the option to “waive escrow” as long as he or she has more than 20% equity in the home. It is quite uncommon for lenders to circumvent escrow with a down payment of less than 20%. If you are interested in managing insurance and tax payments yourself, you can ask about waiving escrow. Realize that for FHA, USDA, and VA loans there is no getting around escrow.