We all hear this term thrown around when people are talking about buying or selling a house. It’s used as if it’s common knowledge, and if you’re like me, the first few times you heard someone talk about it, it felt like something you should already know and felt silly asking what it meant. Well now you don’t need to ask what is escrow!
Escrow is a holding when money is in limbo between two parties – an account that money will stay in until both parties fulfill whatever obligations they have that are related to that money.
Once the obligations are met, the money will be released to the appropriate party. I know what you’re thinking, if I wanted an answer like that I could have just checked Wikipedia.
Ok, let’s get into how it impacts you and your new home (something you might not find on Wikipedia).
There are 2 instances when you’ll deal with escrow when purchasing a home:
At the time of the offer:
When you make an offer, and that offer is accepted you will be required to make an Earnest Money Deposit (fancy way to say deposit). This deposit will be held in an escrow account. This deposit will usually be between 1-2 percent of the total sale and will eventually be subtracted off your down payment.
The point of the escrow account in this case, is to make sure you actually have the deposit and can produce it. It’s also to ensure that the seller can’t take the deposit and cash it before the closing date.
You never want to give the deposit directly to the seller, it might be the last time you see it. The seller will not be able to get this money until all of the conditions of the sale are met. This might include conditions such as a home inspection or specific items that the seller is required to fix before closing. The escrow account in this case protects both the buyer and the seller.
Escrow account with your lender:
Often you’ll have an escrow account set up with your lender. You will make payments to this account for your mortgage, taxes, and home insurance. Your lender will then transfer money to the appropriate institutions when it’s due.
By having you pre-pay taxes and home insurance on a monthly basis, it protects the lender. If your taxes don’t get paid, the government can put a lien on (a right to keep possession of property belonging to another person until a debt owed by that person is discharged), or repossess the home. When this happens you can guess who gets paid first between the government and the lender.
Similarly, if your insurance doesn’t get paid and the house burns down, who ends up footing the bill? Technically you, but if you don’t have the money to pay, the lender is still the one who ultimately loses.
What I imagine you’re thinking now is, ‘great, this account protects everyone else.’
Technically you’re right, but it can be a great benefit to you too. For large bills such as taxes and home insurance, many people have a tough time being diligent enough to save for them over the course of the year.
It’s easy to tell ourselves “I’ll save for that next month.” But next month never comes, until the end of the year when you get the big bill and you haven’t been saving at all.
By setting up an automatic payment for these two items, you’ll never have to worry about the money being there when it’s needed. And trust me, you’ll have many other payments to worry about, without adding these 2 to the list.