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Homeside: Your Modern Mortgage Blog

What is an escrow account and how does it work?

Posted by Rachel Guthrie on February 28, 2017

When you go to buy your first home, you may be asked if you want to enroll in an escrow account. Depending on your loan program or lender, you may be required to have one.

An escrow account is used by your lender to make payments on your behalf to cover property taxes, homeowners insurance, or mortgage insurance.

You could also pay flood insurance out of this account as well. Your lender will collect escrow funds from you as part of your monthly mortgage payment.

Many homeowners love this option because it ensures that your bills are paid in full and on time. This is also a nice option if you do not want to have to calculate potential year-end costs and budget for those large payments separately. Instead, each month the lender will collect 1/12th of your estimated annual insurance and tax bill in addition to your portion of the mortgage to cover principal and interest of the loan.

Most lenders require an escrow account because, when lending a large sum of money for a borrower to purchase a home, the home then becomes collateral for the loan. The bank wants to ensure that the property is being properly insured so that it can be replaced and repaired if damage occurs. The lender also wants to lower the risk of a tax lien being placed on the property if the borrower neglects paying their taxes.

Your lender will provide you with an annual statement that details the amount collected in your escrow, your transaction details, and how it was dispersed. Homeowner’s insurance premiums and property taxes are subject to change and adjust over time, so there is a good chance that the amount of your escrow payments could change throughout the year. In your annual statement, you can see if you have an overage or short in your escrow account. With an overage, you will be refunded the difference and with a shortage, you will have to either make up the difference in one payment, or by increasing your escrow payments.

Regardless of whether or not you’ve set up an escrow account with your lender, these bills are still fully your responsibility and it is your duty to ensure they are being paid out on your behalf without any mistakes.

Speak with your mortgage originator if you have any questions about your escrow account or a potential escrow account for your future mortgage. 

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