What is an Escrow Account?
If you recently bought a house, your lender may have mentioned the term escrow. What does it mean?
Essentially, an escrow account collects small amounts of money each month and uses it to spread out the cost of taxes and insurance over the course of the year.
Generally, your monthly mortgage payment is made up of two parts.
The first part goes toward paying down your loan and includes both the interest and principal. If you have a fixed rate mortgage, this amount will stay the same for as long as you are paying the loan.
The other part covers expenses that usually come due in lump payments and includes both the taxes for your home as well as any property insurance, mortgage insurance, or flood insurance.
This money goes into an escrow account, which your lender uses to pay your tax bill and insurance fees on your behalf throughout the year. This makes it easier to budget, because your payment stays the same from month to month rather than requiring you to gather the funds for large one-time payments.
There are a couple of things to remember. Because both taxes and insurance rates can change, your lender will conduct an escrow analysis each year to determine if you’re under- or overpaying on your escrow, then adjust your rates accordingly.
You may also have to keep a minimum balance in your account to cover any shortfalls.
If your equity is less than 20% of the value of your mortgage or if you used certain types of home loans, you are required to have an escrow account.
And even if your equity is greater than 20%, an escrow account is still a great budgeting tool. Many homeowners keep their escrow account even after their mortgage is paid as an easy way to save up for taxes and insurance.