What is an Escrow Account?
Here’s what it means when a house is "in escrow," and how it works.
Buying a house typically requires you to hand over a large sum of money to a perfect stranger. Although most people are good-natured, it’s better to be safe than sorry. That’s where an escrow account comes in. It’s a secure place for both you and the seller to store funds or assets while you’re agreeing on terms.
What’s the meaning of escrow?
The straight-up definition of “escrow,” according to Merriam-Webster’s, is “a deed, a bond, money, or a piece of property held in trust by a third party to be turned over to the grantee only upon fulfillment of a condition.” Think of it as insurance, or a guarantee you’ll get what you’re paying for.
What is an escrow account?
An escrow account is a safe place to deposit funds while two parties iron out the details of a transaction, such as a real estate deal. The buyer and the seller deposit funds into the escrow account, which is overseen by a trustworthy third party. The funds are held in the escrow account until both sides meet their obligations.
How does an escrow account work?
An escrow account protects both the buyer and the seller. Let’s say you’re buying a house and, as part of the deal, the seller agrees to repair the roof. With your down payment on the house, you pay a small fee called “earnest money” toward the total sale price to let the seller know you’re serious. Of course, you also want to make sure the seller fixes the roof. Rather than giving your earnest money directly to the seller, you deposit it into an escrow account for safekeeping. The seller can’t touch those funds (and neither can you) while they’re “in escrow.” Once you’ve completed the deal, the seller gets paid.
You can also use an escrow account after your home purchase. Part of your mortgage payment may go into an escrow account to cover certain recurring expenses, such as property taxes and homeowners insurance. If you’re not good at saving, an escrow account can be helpful. For example, rather than paying a large tax bill once a year, a portion of your monthly mortgage payment can be routed to an escrow account. At the end of the year, you can use the funds you need to pay taxes.
Your mortgage lender, which is responsible for any late payment penalties from your insurance company or tax agency, may prefer that you put money into an escrow account to ensure property taxes and home insurance premiums are paid on time. The lender has access to your escrow account and makes the payments for you.
Do I need an escrow account?
An escrow account is only required if you have a federal USDA or FHA mortgage loan. If you have a conventional mortgage, an escrow account isn’t required, but lenders generally recommend or require one if you put less than a 20 percent down payment toward your home because you are seen as a higher risk to the lender.
What can an escrow account pay for?
Homeowners may put money into an escrow account to cover:
- Property taxes.
- Homeowners insurance.
- Private mortgage insurance.
- Mortgage payments (for a “cushion,” such as two months’ worth of payments).
How do I pay into an escrow account?
Most financial institutions allow you to pay into your escrow account using a major credit card, electronic bank transfer, or an online payment service such as PayPal.
How does an escrow account pay out?
When bills are due—such as your property taxes or homeowners insurance—your bank or escrow company withdraws funds from the account and pays the bills for you. You do not need to set anything up or manage the transaction.
What happens to my escrow account if I sell my house?
When you sell your home, you’ll receive a statement at closing that shows your escrow account balance on that date. However, your final balance won’t be determined until your mortgage—and any outstanding bills—are paid off. Once that happens, you’ll receive a check for the final balance.
If you’re buying a new home, you can’t use your existing escrow account. You’ll need to close escrow on your previous home and open a new escrow account to purchase your next home. If you are buying a second home and will have two mortgages, you can open a second escrow account for the new mortgage, but you cannot use your existing escrow account that is tied to your original mortgage for your new home.