Inside Scoop on Escrow

Get the Inside Scoop on Escrow

 Dottie Wells, Home Actions, Long & Foster Real Estate

"Escrow" is a strange word, and one that most people don't hear every day. Yet if you're closing on a home or seeking a mortgage from a lender, you'll likely encounter the terms "escrow" or "impound account" sooner rather than later.

To hold funds in escrow means that the lender requires you to deposit certain funds into a special account (also called an impound account) to ensure that the money is available to pay bills such as real estate taxes and insurance. Many mortgage companies and banks require purchasers to open an escrow account, especially if they're putting very little money down on a home.

Not everyone is required to have an escrow account. Banks or lenders sometimes waive escrow if the buyer deposits 20 percent or more on a real estate purchase as a down payment. Typically they view such buyers as good risks because these buyers have saved a considerable chunk of money, and therefore the lenders have more confidence in such buyers to pay their bills over time.

How Escrow Works

Most escrow accounts are opened to collect and distribute money to pay real estate or property taxes as well as homeowners insurance. Lenders prefer escrow accounts because it assures them that these bills will be paid. The amount of both property taxes and homeowners insurance for the year is added up and then divided by 12. The resulting amount is added to the mortgage payment each month so that homeowners pay all three bills — the home loan, property taxes and insurance — monthly.

If insurance rates or taxes rise, the escrow payments will rise accordingly. Lenders often can't calculate the exact amount to the penny, since tax bills can quickly change, but if they collect considerably more than necessary, they will need to give you a refund.

Should You Use an Escrow Account or Not?

Whether you need an escrow account is often up to a lender. If you have a choice in the matter, consider the following:

• Are you disciplined with money? If you have no trouble saving your money, then you may not wish to use an escrow account. People who are disciplined about saving for large payments don't feel the sting of paying their insurance and taxes at the end of the year. On the other hand, if paying such a hefty bill is terrifying, then breaking it into 12 payments via an escrow account makes better sense. 
• Will your money work harder elsewhere? A corollary to the above is that disciplined savers often invest their money. Such investments can yield good dividends. If the chunk of money you'd invest into the escrow account can make more for you elsewhere in a good investment for the remainder of the year, then it may make sense to forgo escrow, invest the amount and pay the bills when they are due instead of monthly.

Escrow payments aren't for everyone, but they are a standard in the world of home ownership. Talk to your mortgage company or lender to determine if you're required to open an escrow account when you buy your home.