What Is an Escrow Account, and How Does It Work?

There are two types of costs involved in taking out a mortgage.

First, there are the initial outlays such as down payment, appraisal cost, and lender fees.

Second, once you own the property, you’ll have ongoing expenses such as property taxes and homeowner’s insurance.

To help you manage these ongoing expenses, your mortgage servicer (which may be different than your lender) will set up an escrow account. You’ll pay into it each month as part of your mortgage payment. Your servicer will then pay certain expenses out of the escrow account on your behalf when they are due.

You may wonder why you can’t simply pay all of this on your own. In some cases, especially with larger down payments, you can. In many instances, though, particularly with FHA loans, this account is required.

There are several reasons lenders do this. The first is that it forces you to plan for expenses that will be payable eight, ten, or twelve months down the road. It also protects you from defaults. For example, if you were to stay current on your mortgage payments but fall behind on the property taxes, your taxing body could take ownership of the property.

Over time, expenses such as homeowner’s insurance may change. To adjust for these changes, once a year your escrow payment is adjusted. If too much was collected, a refund is issued. If there is a shortage, money is collected or added to future payments.

For more information on escrow accounts, contact your mortgage professional.