Understanding Escrow

“Escrow” is one of those words that mean several different things in the same industry. The purest definition of escrow is holding money by a third party until some condition is met, and then the money is released. In the mortgage world, this could be:

• An escrow company is the same as a title company – they will work with you on closing day to sign the documents and will collect the necessary funds from all parties and distribute them.

• In some parts of the country, escrow is another term for your earnest money deposit–the amount of money you put down when signing a purchase agreement and then applied toward your down payment. Being “in escrow” in this sense means you’re in the period between signing the contract and signing the closing docs.

• An escrow holdback is where parts of the home have not been completed, so a portion of the proceeds of the home are held back until the home is fully complete.

But the most common definition of escrow relates to your mortgage payment. Your escrow account is designed to help you budget for your property tax and insurance payments when they’re due. Each month, a part of your mortgage payment is for your taxes and insurance (one-twelfth of the annual amount). That portion is put into an escrow account each month, and then your mortgage company pays your taxes and insurance on your behalf.

Most people want to escrow in their mortgage; it means you don’t have to remember or save up for those taxes or home insurance payments. You can just budget for that “all-in” mortgage payment each month.

You may be able to just escrow for one or the other, or not escrow at all. Each mortgage lender has a maximum loan-to-value amount where they'll allow you to waive escrows after that point. Typically, once you have 20% equity in the home (80% loan-to-value) you can choose to waive escrows. One of the main reasons you might want to do this is if you’re a big credit card points person. There is no fee for most insurance companies to pay your premium on a credit card so you can get rewards points. However, most counties charge 2-3% in fees if you pay with a credit card, which would cancel out any points you might get.

Alternately, waiving escrows in your mortgage means that you won’t have to bring funds to closing to set up your escrow account. If you close on a mortgage with escrows, part of your closing costs will include funds so that the escrow account will have enough in it when payments are due. For example, if you close in January and your first-half taxes are due in April, you’ll make two mortgage payments before then. You need 6 months of taxes in the account in order to make the tax payment. So at closing you’ll be bringing the remaining 4 plus cushion. Waiving escrows means you will not need to bring these funds to closing–but you will need to be ready to make the payments on your own.