Escrow
Escrow refers to two related concepts in mortgage lending. During the transaction, an escrow account held by a neutral third party safeguards funds and documents until closing conditions are met. After closing, a lender-managed escrow account collects monthly deposits for property taxes and insurance, paying those bills on the borrower's behalf.
What This Means
Escrow During the Transaction
When a buyer submits an offer and it is accepted, the earnest money deposit is placed in an escrow account managed by the title company, attorney, or escrow agent. These funds are held securely until closing. If the transaction closes successfully, the earnest money is applied toward the down payment and closing costs. If the deal falls through under a contingency, the funds are returned to the buyer per the terms of the purchase agreement.
Escrow After Closing
Most lenders require borrowers to maintain an escrow account for the ongoing payment of property taxes and homeowners insurance. Each month, the borrower pays one-twelfth of the estimated annual tax and insurance costs as part of the mortgage payment (often referred to as PITI: principal, interest, taxes, and insurance). The lender holds these funds and pays the tax and insurance bills when they come due.
Under RESPA regulations, lenders may maintain a cushion of up to of escrow payments as a reserve. Lenders must conduct an annual escrow analysis to reconcile projected costs with actual disbursements. If there is a shortage, the lender may increase the monthly escrow deposit or allow the borrower to pay the difference in a lump sum.
Escrow Waivers
Some lenders allow borrowers to waive the escrow requirement, particularly on conventional loans with lower LTV ratios. An escrow waiver typically requires at least equity and may come with a small increase to the interest rate (often ). Borrowers who waive escrow assume responsibility for paying taxes and insurance directly.