What Is “Escrow”?
When you’re buying a home — whether as a first-time home buyer or an experienced one — there’s a better-than-average chance you’ll encounter confusing jargon, and unfamiliar terms and phrases.
One such term is “escrow”.
Even more confusing is that “escrow” can mean different things depending on where you live.
In California, for example, the phrase “close of escrow” means that a real estate transaction has been completed and the home sale has been made final.
A mortgage escrow means something different.
In mortgages, escrow refers to the accounts used to pay a homeowner’s property taxes and hazard insurance.
Each month, you send to your lender 1/12 of the annual amount due for taxes and insuance along with your usual mortgage payment. Then, when the bills come due, the lender pay them on your behalf.
Together, your payment is known as — principal, interest, taxes, and insurance.
The Benefits Of An Escrow Account
As a homeowner, you always hope to get the lowest possible; and, one way to lower your rate is to agree to escrow your real estate taxes and your insurance.
Why do you get a lower rate when you escrow? Because escrowing your taxes and insurance makes it less likely your home’s tax bill won’t get paid; or, that its insurance coverage will lapse.
When you escrow, the lender doesn’t have to worry about a seizure on the property by tax authorities, nor do they need to fear losses from property damage resulting from inadequate insurance coverage.
Escrowing reduces your lender’s risk, so your lender rewards you with a lower, better mortgage rate quote.
It can also simplify your life a bit.
Instead of managing your real estate tax and due dates on your own, when you escrow, your mortgage lender pays your bills on your behalf.
Escrow accounts can also make it easier to budget.
Instead of making large payments to your loan taxing authority twice annually and to your homeowners agent, you jut pay a small amount monthly and the money is “saved” for you.
How Lenders Manage Your Escrow Account
When you escrow your taxes and insurance, the law offers you protection from your lender.
The Real Estate Settlement Procedures Act (RESPA) protects borrowers by prescribing how mortgage lenders may handle escrow accounts.
For example, RESPA requires lenders to conduct an annual escrow analysis. The purpose of the analysis is to ensure that a lender does not overwithhold borrower monies.
Lenders may not hold more than 2 months of “extra” payments in escrow for a borrower. Overage must be refunded
RESPA also requires lender to provide borrowers with an Initial Escrow Disclosure Statement with 45 days of closing, as well as an Annual Escrow Account Disclosure Statement at least once every 12 months.
These annual statements are intended to provide information regarding the anticipated tax and insurance activity in the escrow account.
Escrow Accounts Are Sometimes Mandatory
As a mortgage borrower, it’s often your choice whether to escrow the taxes and insurance on your mortgage. Sometimes, however, to escrow is mandatory.
As one prominent example, all loans insured by the Federal Housing Administration (FHA) must include an escrow account. If you plan to use a low-downpayment FHA loan, then, you should plan to do an escrow as well.
USDA loans also require an escrow. VA loans do not.
For conventional loans, the escrow option works differently. It’s optional, but only if your loan-to-value is 80% or less.
Even then, you may want to escrow your taxes and insurance anyway. This is because borrowers who choose to waive escrows are often charged a small fee, or are shown a slightly higher mortgage rate, to compensate the lender for its additional risk.
A tax lien from not paying your real estate tax bill is one of the few lien type that will supersede your mortgage lien. If your taxes go unpaid, your lender could lose its money.
What Are Today’s Mortgage Rates?
When obtaining a mortgage, you’ll typically pay extra money into an escrow account every month, along with the payment for your home loan.
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