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Understanding Mortgages: What is Escrow?

(7/5/2012) In the midst of one of the most uncertain real estate markets in history, it’s more important than ever to be informed. In a continuing series, we take a look at some of the most pressing questions about mortgages, refinancing, home equity, and other real estate options available to you.

There can be a lot of surprises when you obtain a mortgage, particularly if you’re a first-time buyer. Many borrowers are surprised to learn about the need for something called an “escrow” account when they get a loan. Escrow accounts can be used in a wide variety of buying and selling situations, but are especially important and prevalent in mortgages. What is escrow? And what do you need to remember about it?

Most mortgages involve setting up an account held by a neutral third party to provide a home for certain funds. This third party, called an escrow agent, releases the funds from this escrow account when terms of the escrow agreement are met. Escrow agents can be from private companies or title companies, and can be chosen by lenders and borrowers.

The purpose of an escrow account in the case of a mortgage is to set aside money for property taxes and homeowners insurance. Borrowers typically make an initial deposit at closing, then add additional money each month when mortgage payments are made. When taxes come due, usually on a quarterly or yearly basis, the escrow agent releases the funds to pay the bills.

Often borrowers wonder why an escrow account is necessary - isn’t it easier to just make tax and insurance payments on their own? Lenders prefer setting up formal escrow accounts as a self-protection measure - they want to make sure you pay your taxes and your insurance on time and in full. If you don’t, your local government could put a lien on the house, making it difficult to sell and causing the lender a loss.

Borrowers often benefit from escrow accounts as well. Instead of being responsible for a large payment a few times a year, escrow requirements mean spreading those expenses out. It can save on stress and money in the long run.

Escrow may not be a requirement with your mortgage, depending on the state you live in. In those cases, borrowers must pay their taxes and insurance on their own. Lenders may waive the escrow requirement as well if a down payment is more than 20 percent, but they may raise the interest rate slightly in the process.

Remember - while you may have a choice about setting up an escrow account, they are extremely common with mortgages for a reason. With benefits to the lender and to you, they are often a wise choice to help keep your home affordable.  




For additional reading:

Mortgage 101: Escrow Basics: http://www.mortgage101.com/article/escrow-account-basics

Closing and Escrow Basics: http://realsavvyrealestate.com/home-buying-process/closing-and-escrow-basics/

 

 

 

 

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