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What Is Escrow?

When you purchase a home, there are many other expenses involved with taking ownership than simply paying back your mortgage loan. In addition to having to pay for routine maintenance of your home, you will also need to pay for homeowner’s insurance and property taxes. In order to make the process of making these payments easier, however, your mortgage lender will likely provide you with the option to open up an escrow account. Before you agree to escrow terms it is important to gain a better understanding of what an escrow account is and how it works.

What is an Escrow Account?

When you have an escrow account through your mortgage lender, you pay an additional amount of money each month when you make your mortgage payment.  These extra funds are used to pay for your homeowner’s insurance as well as your property taxes, with your lender making the payments for you on your behalf.

Since the amount of your homeowner’s insurance and taxes are estimated, your lender will re-examine your escrow account every year or perhaps every six months. If your escrow account falls short of having enough money to cover your expenses, you may be given the option to pay the shortage upfront or your monthly payment may be increased in order to cover the expenses. If you have excess funds in your account, on the other hand, you may receive a check for the overage.

Why Would I Want to Have an Escrow Account?

Although you may end up paying a bit more than necessary upfront, having an escrow account can be quite beneficial to a homeowner. Namely, you don’t have to worry about making certain your insurance and taxes are paid by a certain deadline.  Not only does this give you one less bill to worry about, you also don’t have to worry about getting hit by a large bill once every six months or so.  Since the expense is spread out over several months and is included in your mortgage payment, they seem far more manageable.

Why Would a Lender Want to Bother with an Escrow Account?

On the surface, it may seem as if providing an escrow account service would be a major inconvenience for a lender. The reality is that having an escrow account set up along with the loan is beneficial to the lender as well.

It is important to remember that lenders have a vested interest in the property that you have purchased. After all, if you default on the loan, the lender will need to try to resell the property in order to recoup the money it has lost. Similarly, if your home is damaged or if it is taken over by the county, city or state because you failed to pay your taxes, the lender will experience a loss. By including your tax and homeowner’s insurance payments in the mortgage loan payment and by paying these expenses, the lender is essentially protecting its investment. For these reasons, you likely will not have an option regarding setting up an escrow account, as your lender will require it in order to make certain these expenses are getting paid.