What Is the Purpose of an Escrow Account?

by Mallory Malesky Google

    Escrow accounts can be used by mortgage lenders either as a service or a requirement for borrowers. The accounts serve to hold money to pay for expenses such as property taxes and homeowner's insurance until they are due. Escrow accounts can ease the borrower's burden of paying a lump sum for these bills by spreading out the payments. Lenders sometimes require payment into escrow accounts so that they know the borrowers are up to date on these bills.

    Features

    Escrow accounts are established on your behalf by the lender and managed by a third party. Each month, you pay a sum in addition to your regular mortgage payment, which is intended to cover the property taxes, the insurance premiums, or both. The surplus is moved to your escrow account and held there until a payment is required for either property taxes or insurance premiums. At this time, they are paid by the lender with the funds from the escrow account, directly to the tax collector or insurance company.

    Benefits

    As long as there is a balance on the mortgage loan, the lender holds an interest in your property as collateral for the loan. The lender wants to ensure that no other party can take a claim on the property. Failure to pay property taxes can result in a tax lien, or eventually a foreclosure. Unpaid insurance premiums will leave the property unprotected in the event of disaster. By collecting payments for these bills up front and paying them, the lender remains in control of the situation.

    Required Escrow

    Many lenders require an escrow account as part of the loan's terms and conditions. This is especially the case if you obtain the loan with less than a 20 percent down payment. Over time, you may be able to cancel your escrow account if you wish to do so. However, this is up to the lender to decide. Generally, your loan-to-balance ratio should be below 80 percent if you want to request to cancel your escrow account.

    Calculations

    The amount paid toward your escrow each month is determined by the lender's best guess with regard to the total due. For example, you might have owed $3000 in property taxes last year and $600 for homeowner's insurance. This would represent a $300 monthly payment added to your mortgage payment of principal and interest. It's common for lenders to collect extra escrow funds, however, to act as a cushion in the event that the amount due for taxes or insurance goes up a bit.

    Considerations

    Each year the lender provides you with a summary statement for your escrow account. It will detail all of the funds paid in and out of the account. At this time, the lender also reassesses the account to determine if an adjustment to the payment amount is necessary. Over time, your escrow payments will change as your property taxes and insurance premiums fluctuate. Sometimes, the amounts due are more than the lender estimated in the previous year. Often the lender will cover the difference. You will see this on your escrow statement. In this situation your lender might require you to pay the difference back immediately, or spread the payments out over another year.

    About the Author

    Mallory Malesky began writing professionally in 2008. Since then, her work has been published on various websites. She has worked in the mortgage industry since 2009. Malesky graduated from Indiana University of Pennsylvania with a Bachelor of Science in natural science.

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