What is escrow and how does it work?

Escrow is a common term you'll hear during the home buying process, but if this is your first home, it's one you might not be familiar with. There are two types of escrow accounts that will come into play when buying a home:

• During the process, funds related to the transaction (from either the buyer or the seller) are held in an escrow account to offer an added level of protection until the transaction is complete.
• After the purchase is complete, your mortgage provider will utilize an escrow account to manage insurance and tax fees on your home.

What purpose does the escrow account serve?

Managed by a neutral third-party escrow agent, an escrow account provides an added level of security during transactions between multiple parties. Any money that's part of your home buying transaction will be held in the account throughout the process. This includes your down payment and closing costs in addition to any money coming from the seller to cover transaction costs or credits to the buyer. These funds are outlined in the real estate contract and distributed after it is signed to cover things like payment to real estate agents, insurance fees, loan origination, and title fee.

The good news is that homebuyers don't have to worry about navigating each of these fees individually. An escrow agent is a key player in the home buying process and will make sure everything is taken care of.

Where does earnest money come into play?

When it comes to signing a real estate contract, a buyer is asked for an earnest money deposit that is held in the escrow account until the transaction is complete. Again, this acts as a level of protection for both the buyer and seller if the transaction falls through for some reason. If a buyer backs out of the transaction, the seller keeps the earnest money as compensation for losing out on other potential buyers. If the seller cannot deliver the home in the agreed-upon condition, the earnest money is released to the buyer and the contract is canceled.

Mortgage escrow account

After you close on your home, your lender might set up a new escrow account. Your annual tax and insurance premiums will be calculated and then divided into monthly payments that are added to your mortgage payment and deposited into that escrow account when paid. As a borrower, you end up making a single payment each month to cover these fees and your lender distributes them appropriately. This amount may change over the life of your loan as taxes increase or insurance premiums change. If you ever overpay, you will be refunded for the overage.

Related terminology you should know

• In escrow – All necessary funds and documentation have been placed in the escrow account and you're now waiting for any conditions to be met. This is usually the final approval on financing, an appraisal, or other requirements to get your loan approved.
• Closing escrow – Conditions are met and you are now a homeowner! Your escrow agent will distribute any funds in the escrow account appropriately and assist in recording any documentation required to note the transition of ownership.

For more helpful mortgage tips and information, check out our blog for more articles to help you decipher new mortgage terms or determine how much is enough for a down payment. Reach out to our team of mortgage experts with specific questions or your unique situation.