What is an Escrow Account and How Does it Work When Buying a House?

When you buy a home, your lender will open an escrow account to pay your taxes and insurance. This account is where the lender will deposit the portion of your monthly mortgage payment that covers taxes and insurance premiums. An escrow account is managed by an external party to hold valuables, such as money, property deeds and personal financial documents, on behalf of two contracting parties until the conditions specified during a financial transaction are met. FHA loans require that a security deposit account be maintained for property taxes, property insurance and mortgage insurance premiums (MIP).

The latter is mandatory for borrowers who make a down payment of less than 20%.Instead of paying taxes directly to the government and insurance premiums to the insurer, an FHA borrower pays one-twelfth of these expenses each month, in addition to paying mortgage capital and interest, into the account. The escrow account holds this money until the bills are due at the end of the year. Lenders who originate VA, FHA, and conventional loans generally require a security deposit account to pay property tax and homeownership insurance. In some cases, lenders may allow the landlord to pay property tax and home insurance as a lump sum instead of opening an escrow account. If you forego the security deposit, keep in mind that some lenders may charge you a fee or increase the interest rate.

During the escrow closing process, a closing or escrow agent (who may be an attorney, depending on the state in which the property is located) will disburse the transaction funds to the appropriate parties, ensure that all documents are signed, and prepare a new deed under the name of homeowner. Until the final exchange is complete, both the buyer's deposit and the seller's property are said to be in custody. When you complete the transaction, the security money you deposit as security deposit will be applied to the down payment on the house. This type of contingency gives the buyer a specific amount of time to sell their current home before closing the security deposit on a new home. Like any other service provider involved in a real estate business, the escrow agent must be paid a fee.

The security deposit plays an important role both in the initial purchase of your home and in the ongoing monthly mortgage payments that follow. The bank or other lender that provides your mortgage will perform its own appraisal of the property, which you, the buyer, normally pays to protect your financial interests in case you ever need to foreclose on the property. You can also ask the mortgage servicer to explain the local seizure account funding schedule that applies to your loan. Escrow agents exist to oversee and help comply with the terms of the sale, such as the buyer's security deposit for a percentage of the sale price. While escrow accounts allow lenders to pay relevant taxes and insurance premiums on your behalf, they have some drawbacks for the borrower. Lenders often require you to maintain a minimum balance in your escrow account to protect against any unexpected cost increases.

Seek the services of a legal, accounting or real estate professional before making any real estate transaction.