When purchasing a property, real estate terminology such as escrow can seem confusing and complicated. But it’s really a basic idea and process for homeowners to budget easier. To help your home buying experience go smoothly, we’ve put together answers to the most common questions about escrow.
1. What is an Escrow?
The definition of an escrow is a legal arrangement where a third party acts as a middle man to handle money or assets being transferred between two parties. The third-party makes sure all conditions of a deal are met before the final exchange occurs.
In real estate, escrow comes up in the following two situations:
- During the process of closing the purchase of a home.
- After the purchase of a home, when the escrow account helps homeowners pay tax and insurance.
2. What Does Being “In Escrow” Mean?
Being in escrow means you are closing the purchase of a property. Escrow begins when a seller accepts your offer for purchase. Although there is a purchase agreement, the seller has not transferred their home to you yet. However, they will take the property listing off the market.
A neutral third party is selected to collect the deposit from the buyer. The deposit is a small percentage of the sale price and is also known as “earnest money.”
3. What is an Escrow Account?
An escrow account is similar to a savings account, except only your loan servicer has access to it. When you are in escrow, all funds and documents associated with the property sale are kept in the escrow account until closing. The escrow agent will ensure that funds are not distributed until both parties fulfill all obligations required in the purchase agreement.
Homeowners also have long-term escrow accounts they establish at closing. This account will hold the portion of your monthly mortgage payment for property tax, mortgage insurance, and sometimes homeowners insurance. Only your loan servicer can withdraw from the account, so when expenses are due, they will pay them for you.
4. Is an Escrow Account Required?
Almost all lenders will require an escrow account, especially if you are making a down payment on your purchase of 20% or less. An escrow account protects the lender’s investment in your property. The government can foreclose on your house if you are delinquent on property taxes, even if your mortgage payment is current. Being behind on your homeowner insurance is also risky if unexpected damages occur.
5. Who Sets Up and Manages An Escrow Account?
A title agent, attorney, or loan servicer gets paid to set up an escrow account during the home purchase process and for long-term accounts at closing. The accounts can be managed by various third parties, such as escrow agents, escrow companies, or mortgage servicers.
During the purchase of a home, a local title or escrow company will manage the escrow account to avoid problems during the sale. Your mortgage servicer usually manages long-term escrow accounts.
6. How Much Goes into the Escrow Account at Closing?
For long-term escrow accounts, lenders often ask buyers to put in two months of estimated property tax and insurance payments at closing. Sometimes they ask you to pay the entire first year of homeowners insurance and start making payments for next year’s bill. To avoid risk, lenders prefer this cushion of funds.
7. Can Interest be Earned on an Escrow Account?
In California, yes, it can. California requires lenders to pay interest on escrow accounts. However, there can be exceptions, so consult with a real estate expert for specifics.
8. Will My Escrow Payments Change?
Yes, your escrow payments can increase or decrease. It mostly depends on your tax rates and the property value of your home. If these two factors increase, your property tax payments will increase. Escrow payments are usually analyzed once a year.
9. Will an Escrow Account Affect My Credit Score?
Yes, delinquent accounts of over 30 days, late payments, missed payments, or other defaults can reflect in your credit report.
10. Are Escrowed Property Taxes Deductible?
Within limits, property taxes for homeowners are deductible. Make sure to deduct the amount that was actually paid out, as this can be different from the amount you put into your escrow account.
11. Should I Consider Not Having an Escrow Account?
Sometimes you can waive the long-term escrow account, such as when you put in over 20% down payment. But there might be a fee to do so. People who work on commission or are self-employed may also find it easier to save aside tax and insurance money in larger sums during good months. Instead of a fixed amount every month. However, it can be beneficial to have a long-term escrow account because:
- It makes budgeting easier when you automatically put money away for tax and insurance expenses
- Someone else manages the tax and insurance bills for
If you want to avoid having a long-term escrow account, you have to be good at saving and keeping track of bills.
We hope these answers clear up your escrow questions. If you still have more, we are here to help!
– The Zion Team
Phone: (858) 324-1951 | To schedule a meeting or call, click here.