How Does Mortgage Escrow account Work?

Dated: September 12 2023

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Understanding how mortgage escrow works is key for homeowners. This account pays your taxes and insurance as part of your monthly payment. Read on to learn about escrow accounts and the escrow process.

What is Mortgage Escrow Account?

A mortgage escrow account is a special account required by most lenders to pay property taxes,  buy a home, home insurance, and mortgage insurance on your behalf. This third party account is funded through your monthly mortgage payment.

Escrow provides convenience by including these recurring homeownership costs in one payment. It also protects lenders by ensuring taxes and insurance are paid on time. The account is typically managed by your mortgage servicer or an escrow company.

Types of Escrow Accounts

The two main types of escrow accounts are tax and insurance escrows, which are used for most standard mortgage loans. A tax and insurance escrow is funded by the borrower's monthly payments, and the lender uses it to pay property taxes and homeowner's insurance premiums when they are due. 

Another common type is a completion escrow, which is used for construction loans. With a completion escrow, the lender will hold back funds at closing to be released in stages as the home is completed per the contract. This ensures the home gets built as agreed before all funds are disbursed.

In real estate transactions, earnest money escrows may be used to hold the buyer's deposit to demonstrate commitment until closing. Overall, escrow accounts serve an important purpose of designating funds for specific planned payments tied to a property.

How Does the Escrow Process Work?

The escrow process involves:

  • Initial funding - You pay a lump sum at closing to start the account, based on a percentage of estimated annual bills.

  • Monthly escrow payments - Part of each mortgage payment goes into the escrow account.

  • Payment of bills - The servicer pays your property taxes and insurance from the escrow balance as they come due.

  • Annual analysis - The required monthly amount is adjusted up or down based on your actual costs the prior year.

  • Surplus refund or shortage payment - If you have a surplus, you get a refund check. A shortage means your monthly escrow payment increases.

Why Do Lenders Require Escrow?

Mandating escrow accounts protects lenders by ensuring earnest money or timely payment of bills tied to the property. It also provides convenience for borrowers by rolling expenses into the monthly mortgage payment.

Escrow is typically required for conventional loans under 80% loan-to-value. Once you reach 20% equity, escrow may be optional but lenders often charge a fee to waive it. FHA and VA loans need escrow for the full loan term.

Escrow Fee

When you obtain a mortgage, most lenders will require you to set up an escrow account to pay property taxes, insurance, and other recurring homeownership expenses. This account is typically managed by your mortgage servicer or a third party escrow company hired by the lender. At closing when you originate your mortgage, you will need to pay an upfront escrow fee to open the account. This escrow fee is usually between $200-500 depending on your mortgage lender and location.

The fee covers the administrative costs of opening and managing the escrow account over the life of your loan. Exact escrow fees can vary, so it's important to ask your lender for details on their specific charges when shopping for a mortgage. The escrow fee may be listed as a closing cost or folded into your total origination charges at mortgage origination. While an additional upfront fee, escrow provides the benefit of convenience and automation paying your homeownership bills from one account.

Pros and Cons of Escrow

Benefits of escrow include:

  • Avoid late fees and penalties
  • Convenience of automatic payment
  • May get insurance discounts paying annually

Potential downsides:

  • Required lump sum funding at closing
  • Loss of interest on funds held in escrow
  • Higher monthly payments than paying directly

For most homeowners, the pros outweigh the cons. Escrow provides peace of mind knowing bills are handled.

Key Takeaways on Mortgage Escrow

  • Escrow accounts pay property taxes and insurance automatically
  • Most lenders require escrow to protect their interest
  • Monthly payments fund the account to pay recurring bills
  • Annual analysis adjusts for any surplus or shortage
  • Benefits include avoiding late fees and penalties
  • Understanding escrow helps homeowners budget responsibly

Now you know the basics of how mortgage escrow accounts work! This process makes homeownership easier for borrowers.

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FAQs

What type of work is involved with escrow?

The escrow agent handles the work of collecting monthly payments, tracking the account balance, and disbursing funds to pay bills when due.

How much is a typical escrow fee? 

Escrow fees are usually between $200-500 depending on your mortgage lender and location.

When is my monthly escrow payment due?

Your escrow payment is part of your total monthly mortgage payment, typically due on the 1st of each month. 

What is included in my monthly escrow?

Monthly escrow generally covers property taxes, home insurance, and mortgage insurance premiums.

Who is my mortgage servicer for the escrow account?

Your mortgage servicer is the company that manages your loan and escrow account on behalf of the lender. 

Why is my escrow account held separately?  

 Escrow accounts are held by third parties to ensure payments are made on time.

What are tax and insurance payments from escrow used for?

Funds disbursed from escrow pay your property taxes and home insurance bills.

Do I need private mortgage insurance with an escrow account?

If your down payment is less than 20%, PMI may be required and paid via your escrow account.

What is an escrow analysis for?

An escrow analysis compares estimated to actual costs and adjusts your monthly payment accordingly.

Can I choose my mortgage company for escrow?

 Your existing mortgage servicer typically manages the escrow account on your loan. 

How do I check my escrow account balance?

 You can check your balance on monthly statements or by contacting your mortgage servicer.

What is an escrow account also called?

Escrow accounts are also known as impound or trust accounts.

Do I need a separate escrow account for each mortgage loan?

Yes, each loan will have its own dedicated escrow account.

What are the two types of escrow accounts?

Tax and insurance escrows are most common, but there are also completion escrows for construction loans.

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