If you’re looking to purchase a new house, you’ll notice the term “escrow” gets thrown around quite a bit. That’s because escrow is a major part of the home buying process. In this article, we’ll explore what an escrow account is, how it works, and how it can benefit you.

What Does Escrow Mean in a Mortgage?

An escrow is a legal agreement that involves a third party that handles the money or assets related to a transaction while the details are hammered out. 

Simply put, you can look at escrow as the mediator between the home buyer and the home seller. Escrow holds onto the money while the buyer and seller discuss the sale of the home, and eventually come to an agreement.

How Do Escrow Accounts Work and What Are The Different Types?

When you’re working through the purchase of a home, the lender will typically set up an escrow account, then calculate annual tax and insurance payments. Once that’s done, they’ll divide the result by 12 and add the resulting figure to your mortgage payments. This is the amount that will go into the escrow account. It will be added on a monthly basis by the lender and will go towards insurance and real estate taxes when they’re due. 

The Types of Escrow Accounts

Generally speaking, there are two types of escrow accounts associated with home-buying — the real estate escrow account and the mortgage escrow account. 

  • The real estate escrow account protects the interest of both parties. It is held by a third party, separate from both the seller and the buyer. They hold all funds, instructions, and paperwork for the upcoming real estate transaction. This includes the down payment and the deed to the home.
  • A mortgage escrow account is set up by the lender financing the purchase of the home and only concerns the buyer. The purpose of the account is to pay all insurance premiums and property taxes on behalf of the buyer. As discussed prior, monthly amounts are deposited into this account by the lender, and then all home-related costs like insurance and property taxes are paid automatically. These exist only after the close of escrow of the real estate purchase.

Should You Get An Escrow Account?

Escrow accounts come with both pros and cons, which you should consider when deciding whether or not to get one. This section is for you if you’re asking yourself, “Should I get an escrow account?”

The Pros of an Escrow Account

  • An escrow account may lead to a lower mortgage cost overall. Some lenders will provide a discount when you decide to use an escrow account.
  • Payments for insurance and taxes are more manageable when you elect to use an escrow account. Rather than paying them in full, you make small installments throughout the year. 
  • Individuals who aren’t avid savers can benefit from an escrow account. Since the payments for taxes and insurance are typically made twice a year, it can be difficult to plan for them, especially for people who have a hard time saving money.
  • There’s less risk of forgetting to pay when you have an escrow account since your lender pays the costs for you. If you do miss real estate tax or home insurance payments, there can be large penalties. Letting someone else be responsible for those payments can remove some stress.
  • Budgeting is easier with an escrow account since the extra costs associated with owning a home are included in your mortgage payment.

The Cons of an Escrow Account

  • Escrow accounts can lead to higher monthly payments since they’ll include installments for home insurance and real estate taxes. If you’re guaranteed to see an influx in cash when these payments are normally due, then you can make your monthly budget a little bigger by excluding an escrow account.
  • Depending on when you’re setting up an escrow account, you may be required to deposit more. This leads to a higher upfront cost, which can also stretch your budget thin.
  • If you’re good at managing your money, then an escrow account may tie up valuable funds that you could be using to make more money. This is something you should consider since the monthly installments being held cannot gain interest.

Explore Ratecloud’s Mortgage Options

Escrow may be one of the more complicated parts of buying a home. Escrow accounts aren’t used in many other industries that people encounter on a day-to-day basis. As such, knowing what escrow is before buying a home can prepare you to make the best decision rather than having to make one last minute. Learn how Ratecloud can simplify your mortgage journey! Head over to our website and get started on your digital mortgage application today!