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What Does Escrow Really Mean and How Does it Work with a Mortgage?

During the home buying process you’ll hear the term “escrow” quite a bit (or “impounds” if you’re in California or Hawaii), so it’s important to know what this term means for you once you close on your home and the property becomes officially yours!

What is escrow?

Many mortgage lenders hold money that you’ve paid in an escrow account to pay your property taxes, homeowner’s insurance, and in some instances even your homeowner’s association (HOA) fees. This makes it as easy as possible so you only have to make one mortgage payment a month, and you don’t have to think about ongoing annual payments for your insurance and property taxes.

To put it simply, your lender calculates how much your property taxes and homeowner’s insurance premiums are for the entire year, and then divides them by 12 (one payment a month). You’ll then pay that amount each month along with your mortgage payment, and in return, your lender will manage the escrow account and submit payments for your annual property taxes and homeowner’s insurance when they are due.

You’ll start making payments into your escrow account on closing day.

Why do I need it?

Depending on your loan program, you may be required to have an escrow account. But, that’s not a bad thing!

Convenience is probably the best part of having an escrow account. With just one single monthly mortgage payment, you’ll cover your principal, interest, insurance, and property taxes. It’s a great way to streamline your budget and to sigh relief that you don’t have to deal with payment deadlines or be forced to make a huge payment all at once.

If you’re able to opt out of an escrow account, remember that you’ll be responsible for your annual property taxes and insurance bills, in one lump sum and on time! You may want to consider requesting an escrow account just for peace of mind.

How does it work?

Tax and homeowner’s insurance bills are typically sent directly to your lender and paid annually. But, you’ll be making a payment toward each of these bills each month. This money accrues in your escrow account and once you’ve reached 12 payments, your lender will pay your annual property taxes and insurance bill for the following year.

At the end of each year, your monthly escrow amount will be adjusted to reflect the actual amount on the tax and insurance bills for your home. If you didn’t pay enough throughout the year, you can usually choose to pay the difference in one lump payment or spread out the difference over the coming year. If you happened to pay too much, you’ll get a refund of the overpaid amount.

Your monthly escrow payment can change from year to year based on adjustments in property taxes in your area or shifts in insurance premiums. You’ll get an annual statement detailing all of the transactions from the escrow account, including the money you’ve paid into it and the money that’s been dispersed.

Keep in mind, in some locations, the property taxes could be separated into different tax bills (for example city and county taxes) instead of everything being rolled into one bill.

Ultimately, an escrow (or impounds) account is a simple way to manage your property tax and insurance payments, and is well worth it. It's just so convenient!

Check out this article for more information about decoding mortgage terms and reach out to us if you have any questions about escrow. 

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