Escrow is an account held by a neutral third-party – i.e., someone who is not directly involved with the mortgage transaction. The account is used to deposit and hold funds, and then disburse them under the conditions of a contract. Escrow accounts are managed by escrow officers and are used to ensure a fair transfer of funds.
Escrow accounts are commonly used upon the signing of a mortgage. The buyer deposits funds – including down payment, taxes, and closing costs - into an escrow account. These funds are not released to the seller until all transactions are completed, and the funds do not change hands until the deed is signed. This eliminates any trust issues between the buyer and seller.
Escrow accounts are also used by mortgage companies to insure that property taxes and home insurance are paid properly and on-time. The buyer typically makes deposits to the escrow account as part of the monthly payments, and the lender then ensures that the funds are used to pay taxes as they come due. This minimizes risk for the lender that the borrower will not pay taxes or insurance properly, which could lead to the home being seized by the IRS.
Escrow also makes payments easier for borrowers because they can make deposits into the account in monthly installments, rather than pay the tax and insurance premiums as one large payment. However, most escrow accounts do not earn interest, so you’ll want to make sure your escrow payments are as small as possible. Some landlords may ask for several months deposit upfront, to provide cushioning in case of delinquent payments.
Escrow accounts can be complicated, but they are an important part of a mortgage transaction. Make sure you thoroughly understand your escrow contract, or have your escrow officer explain it to you. Furthermore, check your escrow account annually to ensure that your lender is spending your money properlty, and that taxes are being paid on time. Escrow for taxes is, unfortunately, required under the terms of most mortgages; make sure yours is being used responsibly.
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