What's an Escrow Account?

So, you looked at the breakdown of your mortgage payment and noticed you are paying into Escrow, and you want to know “What is that?”

If you buy a house using loan, it is likely you will pay money each month on top of your mortgage principle and interest payments into an escrow account. This account is what the bank or lender uses to pay property taxes and insurance premiums on the house on your behalf.

Why does it go through the lender instead of me paying that myself?

Lenders want to protect their investments. When they lent you money, it was with the understanding that you would pay it back plus interest. If you stop paying, the lender can take your house away from you through a foreclosure. However, to get their money back out of the house they need to be able to sell the house again.

Insurance example: A fire burns down your house and you do not have insurance. If you cannot afford the mortgage and the bank or lender tries to foreclose on you, all they can take from you is the land and ashy remains of the house. It would be hard to sell that for the same amount of money that you borrowed from them to begin with. In order to protect themselves from losing the asset of the house in the case of a disaster, they have you pay extra every month into an escrow account. When your insurance premium is due, they can pay out of the escrow account and there is no lapse in coverage, and they make sure their investment is protected.

Extra information: Some mortgages require specific insurance coverage. A VA loan, for example, requires flood insurance if your new home is in a flood zone. Some conventional mortgages do not require this insurance, even though they may recommend it. VA loans will require this, but it will also be paid out of your escrow account. It is a good idea to look at mortgage requirements to determine what your final monthly payment will be, because the escrow payments can add up if you are required to hold multiple types of insurance policies.

Okay, so the insurance thing makes sense, but why do they care if I pay my taxes on time?

Did you know you can lose your home and/or land if you stop paying your property taxes?

The lenders know that if you forget or choose not to pay your property taxes, eventually you can lose the title to the house. It takes years, but if you have a 15- or 30-year mortgage, you could still owe money on your loan when you lose the house to taxes. The lender wants to protect their investment, so they will require a monthly payment to the escrow account so that when taxes are due, they can pull them out of the escrow account.

If they do not do this, and you stop paying property taxes for several years and someone else acquires the title to the property through a tax sale, the lender also loses all rights to the property. This means they have nothing to secure the loan they gave you and that makes them nervous.

An escrow account is a way for the lender to protect their investment in you and your mortgage, it also mean’s you don’t have to worry about a once a year tax payment or insurance premium, because the lender has automated it for you.

Have more questions? Drop them in the comments.

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Cheers.