What is an Escrow Account & How Do they Work

As a prospective home buyer, you hear mention of escrow accounts from your Realtor® and your lender. The most commonly known escrow accounts allow for payment of certain home-related costs to be set aside in advance. They are also in effect a way for the lender to offer low down-payment mortgage options to you as a home buyer, making it easier for you to make your desired home purchase.

One type of escrow account is the Realtor®’s escrow account. The Realtor’s escrow account is used to hold funds given to them when a offer to purchase is made and/or when a sale occurs. By law, the Realtor is required to keep this account separate from their operating funds.

The other type of escrow account is the mortgage escrow account. The mortgage escrow account is a special account set up by the lender in which money is held for their client’s property taxes, fire insurance and mortgage insurance premiums. It can also be utilized for withholding monies as a condition of mortgage approval.

Escrow accounts assure the borrower that their expenses will be paid in a timely manner by the lender. Each month the lender collects from the borrower one-twelfth of the combined debt for the items listed above. When each item is due, the lender will make direct payments on behalf of the borrower. If the premiums for escrow items increase, and if the lender failed to account for these increases, the lender will pay the shortage and settle up with the borrower later.

Real estate property taxes are levied as liens. Having escrow accounts assures the borrower and lender that liens on the property are paid on time.

Not every buyer needs to establish an escrow account. A buyer who has made a very large down payment — perhaps one-third of the price of the property —  is the exception.