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What is Escrow and How Does it Work?

What is Escrow and How Does it Work?

As you move through the home buying process and start talking about calculating and making mortgage payments, you are sure to hear the term "escrow." It's a legal term that not everyone is familiar with, but it's an important one to help you understand how much you pay to whom, when, and where.

What is Escrow?

"Escrow" is a financial agreement between two parties to have a third party hold money, paperwork, or other assets on their behalf while a transaction is being completed.

There are several ways an escrow account can be used during a real estate transaction. For example, when you put down earnest money to show a good faith offer on a home, that money does not go to the seller directly at that time, but goes into an escrow account established by their title company or broker, to keep it safe and in third party hands until the transaction is completed.

Essentially, an escrow account is for the "safekeeping" of funds that will be paid out in the future.

What You Need to Know About Escrow Accounts

One of the most important ways escrow accounts are used is when your lender establishes a mortgage escrow account to help you manage your monthly payment.

Your monthly payment is not just the payment due on your loan; it can consist of principal, interest, property taxes, and homeowner's insurance. The money collected from you each month for property taxes and insurance goes safely into the escrow account until it is due, and then your lender pays them on your behalf.

So an escrow account makes it simpler for the homeowner and ensures that an expense like insurance is paid as part of your monthly mortgage statement. Your lender sends out the payment monthly, quarterly, or annually, depending on your insurer.

The same goes for property taxes. Instead of being hit with a separate large bill annually, your taxes are folded into your monthly payment.

Do I Need An Escrow Account?

The short answer is no, but you do have to be disciplined to set aside the money you'll owe for taxes and insurance and be diligent about paying them on time.

Some loans, such as FHA loans and VA loans, require an escrow account. With conventional loans, it is up to the lender.

The argument against escrow accounts is that you are prepaying for bills or services, and your lender is holding (and using) that money interest-free. But for most buyers, the convenience and peace of mind of an escrow account outweigh the potential benefits of investing or saving that money in the short term.

In short, a mortgage escrow account helps lenders and mortgage holders plan for and pay for monthly expenses and provides a safe and transparent way of doing so.

At Citizens Bank, we believe your dream home should come with a dream mortgage; let us help you calculate what you can afford and find a loan that fits.

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