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What Is Escrow and How Does It Work?

Monday, April 26, 2021

This year, there are more buyers than homes for sale. This means, as a homebuyer, you need to be on top of your game to close on the home of your dreams before someone else snatches it up.

Entering the housing market involves the proper knowledge of real estate terms like escrow. What is escrow exactly?

Read our guide to find out.

Real Estate Terms: What Is Escrow?

Escrow is one of the more common real estate terms that home buyers and sellers hear, but what does it mean?

Escrow is a legal arrangement where a third party temporarily holds large sums of property or money until conditions have been met. One common condition is the fulfillment of the purchase agreement.

When buying a house, after you close on a mortgage, the lender will create a mortgage escrow account. This account holds some of your monthly mortgage loan payments to cover other costs of owning a home.

The escrow account can help you cover real estate taxes, title insurance premiums, and private mortgage insurance if necessary. An escrow account protects third parties by ensuring payments are made on time.

How Does Escrow Work?

An escrow account will get set up on your behalf by the lender. They will configure your annual payments and divide them by twelve to get a monthly total.

The amount you owe each month is added to a mortgage statement. The lender then deposits the escrow portion of those payments into the account each month. When your real estate taxes and insurance premiums are due, they will pay them.

Certain states require an escrow cushion. The cushion helps cover any unanticipated costs, for example, an increase in taxes.

If the escrow cushion turns out to be more than you owe, the difference will be refunded or credited to you.

Can You Set Up Your Own Escrow Bank Account?

The short answer is yes, you can set up your own escrow bank account. However, this is not the best option for everyone.

If you tend to spend more money than you save, it is best to leave the payments to your lender. Any late or missed payments can have serious negative consequences.

Typical consequences of not making these payments include lapse in insurance coverage, penalty charges, or a lien getting placed on your home.

If you consider yourself disciplined when it comes to finances, you may want to control this account on your own.

These payments are usually due once or twice a year making them easy to keep up with.

It is important to note that escrow accounts won't cover all expenses that come with buying a house. You'll likely have to cover utility bills and HOA dues on your own.

Understanding Escrow When Buying a Home

There are various terms you will hear when you are in the market to buy a house. One of the most important real estate terms to understand is escrow.

Escrow is an agreement between the homebuyer and the lender to pay expenses that come with owning a home. If you still have questions after reading this guide, Heartland Abstract is here to help.

Contact us today to speak with a representative about questions, concerns, or to receive an insurance rate quote.

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