When you are talking about a residential real estate transaction, there are actually two different types of escrow involved. There is an escrow attached to the transaction, and then there is an escrow account that is attached to the mortgage. Most lenders require both types of escrow, and most homeowners feel it is easier to have an escrow account rather than trying to pay annual insurance and tax bills.
What Is Escrow?
Before the real estate deal is finalized, an escrow is a third-party service hired to make sure that all of the money involved in the transaction is handled properly. When a seller accepts an offer from a buyer, an escrow for the transaction is immediately established. This escrow is run by a professional organization that monitors and maintains the entire transaction. The buyer will pay a deposit into escrow based on a percentage established by the transaction agreement, and the seller takes the property off of the market and puts it into escrow.
What Is An Escrow Account?
Homeowners have several very important bills to pay on a monthly and yearly basis. The interest and principal for the mortgage are paid on a monthly basis, and then the annual tax and insurance payments are made at various points throughout the year. An escrow account is established, usually through the lender, to collect partial payments for the annual obligations and hold onto those payment until those obligations are due. The escrow account would be responsible for paying the annual insurance and tax bills for the property, while the remaining amount of each monthly payment goes towards principal and interest.
How Is An Escrow Account Managed?
Most lenders review escrow amounts on an annual basis and alter their payment requirements based on the needs of the escrow account. For example, if a lender does an annual escrow analysis and determines that too much money is being taken for the annual payments, then the escrow account administrator will lower the monthly payments. If it is found that the escrow account is not adequately covering the annual payments, then the monthly payment is increased.
Can I Question My Escrow Account?
Many homeowners incorrectly believe that they have no say in how much their escrow account costs them each month. If you are concerned that your escrow account is not taking in enough money each month or if you feel you are being charged too much for your escrow account, then your lender has a process you can follow to challenge your escrow amount. You should be prepared to submit precise information to backup your escrow challenge, but your lender does offer you the chance to speak your mind about your escrow account.
A real estate transaction usually starts with escrow and then that escrow transitions into an escrow account after closing. Escrow is a convenient way for you to pay into the transaction and have the funds properly distributed when necessary. Most lenders require escrow because it prevents homeowners from defaulting on their property taxes or property insurance.