Guide to Escrow: Pros and Cons of Mortgage Escrow Accounts

Escrow is a contractual agreement in which two parties engaged in a transaction retain a neutral third party to hold, protect, and, if necessary, disburse payment upon the deal’s completion. Escrow services typically refer to a real estate transaction and can also apply to banking, stocks, mergers and acquisitions, and online sales. A home or property is “in escrow” until the seller accepts the prospective home buyers’ offer in real estate.

The third party in real estate escrow is typically an escrow officer or escrow agent—an attorney, a title company agent, or a real estate agent—who holds earnest money or good-faith down payment and various documents in an escrow account. The escrow agent then pays the seller once all the terms of the real estate transaction are met and the deal is complete.

Escrow can also refer to an account that lenders establish for homebuyers during the mortgage-closing process. This escrow account holds a portion of the monthly mortgage payments to cover future homeowners’ insurance and property tax payments. The payments are either handled by the mortgage service provider or via a check sent to the homeowner.

Some mortgage lenders and certain types of home loans require borrowers to maintain these accounts for property tax bills and insurance payments (or T&I), which can make these costs more manageable. Here are a few advantages to having an escrow account when buying or owning a home:

1. 1. Money-back protection. Though the buyer, seller, and lender are all protected by escrow, the buyer receives the most protection from the escrow process. If a purchase agreement falls through for any reason, the buyer is assured that the escrow account holder will return their earnest money payment.
2. 2. Taxes and insurance are covered. Establishing a mortgage escrow account ensures that property taxes and insurance premiums are taken care of since the money added to the account goes directly toward these costs. A mortgage escrow account also benefits lenders by ensuring that the homeowner pays those costs, so they don’t have to step in and cover them to ensure their property is protected.
3. 3. Taxes and insurance payments are more manageable. By paying into the escrow account, homeowners can handle taxes and insurance fees in more manageable monthly payments than one sizeable annual sum.

There are a few disadvantages to having an escrow account for buyers and owners, including:

1. 1. Higher monthly mortgage payments: Breaking down taxes and insurance fees into monthly payments makes these large costs more manageable, but they also increase your mortgage. When you establish a mortgage escrow account, your lender will take a portion of your mortgage to pay into it, which means you have to pay a slightly higher mortgage to balance the books.
2. 2. Estimate inaccuracies: An escrow amount is an estimation based on current property tax and insurance premiums. But a homeowner may discover a change in these figures after the home sale due to the mortgage servicer’s reassessment. If the T&I is estimated lower, then the lender may reimburse the homeowner for the difference. If the T&I is higher, the responsibility falls on the homeowner to cover the difference.
3. 3. Fluctuating mortgage: Taxes and insurance premiums are subject to change. If you have an escrow account and these costs increase, so will your mortgage. Paying T&I in one annual lump sum can help ensure a more stable, monthly mortgage payment.

Here is a step-by-step guide that breaks down how escrow works in the home-buying process:

1. 1. The buyer makes an earnest money deposit. Once the property owner and prospective homebuyer agree on a purchase price, a sales contract is issued, and the buyer makes an earnest money payment. This good-faith gesture shows their intention to follow through on the contract to buy the property. The payment is held by the escrow agent in an escrow account and is later applied to the down payment.
2. 2. The closing process begins. While the escrow agent begins closing the transaction, they also help the seller with loan payoffs while assisting the buyer with due diligence on the property, which includes ordering a home inspection, homeowner fees, and homeowners insurance. A title search is launched to verify that the homeowner is the legal owner of the property, and to clear any outstanding debts, like credit card payments, on the property. (In some circumstances, lenders can attach unpaid credit card debt to a property.) The title is then submitted to the lender or the entity that holds the mortgage loan.
3. 3. The closing agent reviews all documents. All papers connected to the transaction are reviewed, including legal and loan documents. Changes to documents are made if necessary, and the closing is scheduled.
4. 4. The transaction is closed. The seller signs the deed to the property over to the buyer, who signs the mortgage. The seller is paid, along with any other real-estate professionals present, and the buyer is the owner of a new home.
5. 5. Disbursement and closing costs. After the home purchase is completed, the next step in the escrow process is the payment of any party involved in the transaction’s closing. Insurance policies are then sent to the lender and the escrow agent.

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