Mortgage Escrow – What is it? How does it work?

Investopedia defines escrow as:  A financial instrument held by a third party on behalf of the other two parties in a transaction. The funds are held by the escrow service until it receives the appropriate written or oral instructions or until obligations have been fulfilled.

In the case of a home purchase, the lender or mortgage holder may take funds from the buyer to pay taxes and insurance. The funds are held or “escrowed” until the time they are due. At that time, the lender sends payments from the escrow account to the appropriate tax department and/or insurance provider.

Lenders usually require that borrowers pay money monthly into “escrow” so that the lender can be sure both real estate tax and property insurance are paid when due. This required amount is added to your monthly mortgage payment.

If you decide to “escrow” your taxes and insurance, the closing HUD1 settlement statement will show that monies have been taken from you to cover the next 12 month’s worth of property insurance and/or property taxes. This ensures that the escrow company will have enough money set aside by you to cover the first payment due for your taxes and insurance on the property you are purchasing.

Check your monthly mortgage statement. It shows a break down of how much is being held out of your monthly payment for escrow, how much of your monthly payment is being put aside toward taxes and insurance. That money is held so that, after your first tax and insurance payment is made, more is immediately accumulating toward what the escrow company will need to make the following year’s payments.

Some buyers decide not to escrow these monies feeling they’re giving up control and allowing the lender to use the money rather than using it themselves.

The decision is sometimes left up to you, the borrower, to escrow or not to escrow. If you escrow, paying attention to when taxes and insurance are due is not necessary as this is handled for you. In addition, no need to come up with a large sum of money to pay your tax bill at year end because you have been “saving” it a little bit at a time all year long from that portion of your mortgage payment that is escrowed.

RESPA, or the Real Estate Settlement Procedures Act, was enacted by Congress to prevent abuses involved with real estate. One aspect of RESPA deals with escrow accounts. By law, a lender has the right to require a borrower to deposit money into an escrow account for property taxes and insurance so the ultimate decision may not be yours.

Most lenders make these payments promptly, however, you may find a late or missed payment. If you feel that your escrow funds have not been collected or distributed correctly, file your complaint with the state’s attorney general or banking commission.

What’s been your experience with escrow accounts?