The word escrow comes up often in real estate, though it also applies to fields like banking and law. Often required by mortgage lenders, an escrow account is a separate bank account used by your lender to pay for property taxes and insurance (source). The term “escrow account” also refers to an account in which a third-party (typically a closing attorney or title company) holds funds prior to the completion of a real estate transaction. To learn more about how escrow accounts work, please scroll down.
How Escrow Accounts Work
As specialized bank accounts that act as fund reserves, escrow accounts come in handy during multiple phases of real estate transactions. The money deposited into an escrow account remains there as a source of funding for a specific purpose or until certain conditions are met. Today we will explore how escrow accounts work in three common real estate situations.
Transaction Escrow Accounts
As we mentioned above, you can use an escrow account to temporarily hold money during a real estate transaction. A third party, known as an escrow officer (often the lawyer or a representative from the title company), will accept documents and deposits from the buyer and seller. This person will hold onto the funds until the parties have come to a final agreement (source). When the parties complete the transaction, the funds, titles, and other rights are disbursed as appropriate. The escrow officer ensures that everyone involved gets paid what he or she is owed.
Escrow Accounts for Repairs and Renovations
Next, sellers who wish to part with a property as quickly as possible can use an escrow program to fund repairs, renovations, and upgrades. The escrow account helps the seller complete the repairs and renovations quickly and affordably. These sorts of changes can make homes more attractive to potential buyers, increasing the likelihood of a fast sale. To learn about PrimeLending’s Buyer/Seller Funded Repair Escrow Program, please click here.
Lender Escrow Accounts
Tremendously common and helpful, lender escrow accounts allow mortgage and loan originators to cover their bases and ensure that they remain in good standing (source). Your lender may use escrow funds to cover insurance premiums, property taxes, or other ongoing expenses.
Here’s how escrow accounts work: Each time you make a monthly payment, part of the money will be applied to your outstanding principal balance and interest, while the remainder will be deposited into the escrow account. Your lender will manage the money, using the account balance to pay off the applicable bills as they’re due (source). The amount of money in the account will vary from year to year due to insurance premium adjustments and tax assessments (source).
Are Lender Escrow Accounts Necessary?
Most lenders require escrow accounts, but some will leave the choice up to you. If you enter the transaction with extremely good credit, proven financial means, and/or the ability to make a large down payment, your lender may offer to forgo the escrow account due to your low risk factor. In addition, some loans (like those insured by the Federal Housing Administration) require that borrowers use an escrow account (source).
Most homebuyers prefer to use an escrow account. It equalizes your property tax payments, so that you can pay the same amount on a monthly basis. It can also help you obtain a better mortgage, as most lenders don’t offer the lowest rates and best options to buyers unwilling to accept an escrow account. Finally, it reduces your responsibility and stress, since your lender will take the reins when it comes to your property taxes and insurance (source).
Avoiding an escrow account will increase your flexibility and your ability to access your money, but it will also require some extra work on your part (source). You will need to pay your taxes and insurance on your own, and you must do it in a timely manner to avoid fees.
What happens to your escrow account after you pay off your mortgage or refinance?
When you pay off your mortgage, the lender no longer needs to pay insurance and other costs on your behalf. If your escrow account still holds a positive balance at such a time, your lender will usually send you a refund after performing a final review. In most cases, they have about 30 days to issue a refund, but the terms of your escrow account agreement may vary (source).
If you refinance instead of paying off your mortgage, the same general refund rules apply if you’re moving to a different lender. Your new financial institution may also require you to use an escrow account, however, so it’s wise not to spend the refund all at once. In the event that you refinance with your original lender, your existing escrow account will most likely remain unchanged and simply transfer to the new loan (source).
As you can see, escrow accounts vary in their purpose and scope. You might use an escrow program to remodel your home before selling it, or you could use escrow accounts during and after the purchase of your new home. To further understand how escrow accounts work, consult with your real estate agent or mortgage lender.
If you’re ready to buy a house and you live in the Kansas City area, contact PrimeLending today. Our team is committed to helping you navigate the home financing process, so that you can purchase the home of your dreams. At our branches located throughout Kansas City, we can help you explore our wide variety of loan products and programs. Plus, PrimeLending utilizes delegated underwriting, local appraisers, and cutting-edge technology to accelerate the underwriting and closing processes. When you’re ready to learn more, please give us a call at 844-701-5626. We would be happy to help you further compare the many types of home loans available to you.