What is Escrow?

by Washington Federal Team on August 16, 2011

Don’t be embarrassed if you’re not sure.  “Escrow account” has several different meanings and three different names. Most of us would have to admit that we really don’t truly understand what “escrow” is or what role it plays with a mortgage loan. Depending on who you talk to, they may call it an escrow, reserve, or impound account.  So here’s the answer: What is escrow?

Regardless of what it is called, the account is set-up by your mortgage lender.  The lender uses these accounts to hold funds on your behalf.  Your lender will then use those funds to pay items such as homeowner’s insurance and property taxes.  Money for the escrow account is collected over time by adding onto the monthly principal and interest payment for your mortgage.  If you’re a homeowner or a first-time home buyer, you may find that an escrow account is a convenient way to manage your budget for these items.  Here are the three most common reasons to use an escrow or reserve or impound account:

1. Your lender requires it.

Lenders may require a borrower to use an escrow account. This allows the lender to add the cost of homeowner’s insurance and property taxes to your monthly payment, and then use those funds to pay for these expenses whenever premiums come due.  Because the lender views your home as collateral for your loan, they have a vested interest in making sure that the taxes are paid and insurance premiums kept current.

2. You enjoy the convenience.

Escrow accounts offer a convenient solution if you prefer a hands-off approach to bills. Since you’ve already put money into the account and payments are made on your behalf, you don’t have to worry about making payments, paying postage or being charged for costly late fees.

3. You want to avoid lump-sum payments.

For those without an escrow account, insurance and tax bills sometimes come due just twice a year. Instead of receiving a large bill for these expenses, your escrow account allows you to budget for these items over 12 months, so you make smaller monthly payments that are easier on your budget.

Admittedly, escrow accounts carry some disadvantages as well.  Escrow accounts do not earn interest, so you miss the opportunity to hold your funds in an interest-bearing savings account leading up to those lump sum payments. Be sure to ask whether there is any maintenance fee associated with your escrow account.  Washington Federal does not charge a fee, but some loan servicing companies may.

Escrow and reserve accounts can be a safe, easy way to make sure you’ve paid expenses associated with home ownership, whether you are required by your lender or prefer the convenience. Ask your lender for additional information.

(By the way, the term escrow account is also used when you are buying real estate and is an account held by an independent trusted third party that receives and pays money and or transfers documents for and between the buyer, seller and lenders.)

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