When you are purchasing a new home one of the terms you are going to come to know is mortgage escrow account.
“But what is a mortgage escrow account? What’s the purpose of it when owning a home?,” you may be thinking to yourself.
Before we get into what a mortgage escrow account is let’s look at what escrow, in general, is…
Basic Concept of Escrow
Escrow is widely used in many business transactions where the buyer and seller cannot make a simultaneous exchange of money and goods or services and neither would want to deliver first without the guarantee to receive later (neither party wants to risk being the one left without the dough).
To resolve the trust issue between a buyer and seller, a third party, known as the escrow, can work on behalf both the buyer and the seller to ensure that once a party fulfills its contractual obligation, the escrow will release to the party what it entitles from the transaction.
Such escrow service is also standard practice in real estate transactions where the buyer deposits money with the escrow and the seller delivers title documents to the escrow, and the escrow firm will not release the funds to the seller or convey the title to the buyer until both the funds and the documents are placed with the escrow.
Purpose of Mortgage Escrow Account
A mortgage escrow concerns the homeowner and the mortgage lender.
Part of the contractual obligations in a mortgage loan agreement is for the homeowner to pay property taxes on time and keep the homeowner insurance up to date. Failing to meet those responsibilities by the homeowner has potential negative effects on the mortgage lender, as a government tax lien on the property or any not-insurance-covered damage to the property could reduce or potentially destroy the value of the collateral that the homeowner has placed with the mortgage lender against the borrower’s home.
In order to have a clean title to the property and a recoverable value of the collateral in the event of mortgage default, the mortgage lender looks for a payment guarantee on property taxes and home insurance by using an escrow account.
How Mortgage Escrow Account Works
Concerned about how protected its mortgage collateral is, the mortgage lender often requires the set-up of a mortgage escrow account that from time to time can release funds to pay property taxes to the county and insurance premiums to the insurance company on the homeowner’s behalf.
The homeowner is responsible for depositing funds into the mortgage escrow account on a monthly basis as part of the mortgage payment arrangement. When the property taxes and insurance premium become due, the escrow firm will transfer the funds to cover the payments.
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Benefits of Mortgage Escrow Account
A mortgage escrow account provides benefits to both the lender and the homeowner.
For the mortgage lender, an escrow account brings added security and assurance about the safety of the its mortgage collateral, the borrower’s home. With the escrow account paying property taxes on time and keeping the insurance policy up to date, the mortgage lender needs not to worry about any seize on the property by tax authorities or losses from property damage uncovered by the insurance company.
For the homeowner, an escrow account provides a way to better budget property tax and insurance payments. Instead of having to come up with a lump sum when the bills are received, making smaller, monthly deposits into an escrow account reduces the possibility of funds shortage.
Additionally, with an escrow account, no more due dates to remember as the escrow company will send in payments on time on the homeowner’s behalf.
When buying a home, a buyer needs to know what is required in the mortgage escrow (home insurance, property and local taxes) as well as realize how the escrow will impact their monthly bills as the escrow amount will be higher than just the mortgage payment.
This is a crucial concept in calculating if you can afford a home, and if so, what you can really afford.