'Escrow' is explained in detail and with examples in the Real Estate edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.
Escrow is a concept that relates to a sum of money that is kept by an uninvolved third party for the two parties involved in a given transaction. In the U.S., this escrow is most commonly involved where real estate mortgages are concerned. Here is it utilized for the payment of insurance and property tax during the mortgage’s life.
When you place your money into such an escrow account, an escrow agent who is a neutral third party holds it. This agent works on behalf of both the borrower and home lender. The escrow agent’s job in the transaction is to act as the principal parties instruct him or her. As all transaction terms are fulfilled, the money is then released. These escrow accounts may be a part of transactions ranging from small purchases affected on online auction sites to building projects that total in the multiple millions of dollars.
Escrow is utilized in these property transactions when it is time for your mortgage to close. At this point, the borrower’s lender will commonly insist that you establish an escrow account for paying for both home owner’s insurance and property taxes. You are required to make a first deposit to the account. After this, you make payments into the account each month. Typically, these are simply a part of your monthly mortgage payments. When it is time for your insurance premiums and taxes to be paid, your escrow agent then releases the funds.
The concept behind this escrow is to give your lender peace of mind and protection that your insurance and taxes are both paid in a timely manner. Should you not pay your property taxes, the city might place a lien on this house, making it hard for the bank to sell it if they needed to. Similarly, if a fire burned down the house and the insurance premiums had not been paid, the bank would not have any underlying collateral for the mortgage anymore.
You the borrower also benefit from this escrow account. It allows you to stretch out your taxes and insurance costs over the course of the entire year’s twelve payments. As an example, your annual property taxes might prove to be $3,000, with a yearly insurance cost of $600. This would mean that when spread out over twelve even payments, the escrow costs would amount to only $300 each month.
The nice thing about escrow accounts and payments is that they come with an included safeguard built in. Should you miss a single payment, then the responsible lender is still capable of paying the accounts in a timely manner. The U.S. Federal law actually stops these lenders from storing up in excess of two months’ worth of payments in escrow. As insurance and tax amounts will vary a little from one year to the next, the lender will have to examine and make adjustments to your annual escrow payments.