Buying your first home can be super exciting—and nerve-wracking! Just like that, you’re responsible for any repairs and maintenance, plus a plethora of new bills like your property taxes and homeowner’s insurance. Luckily, you may not have to deal with these expenses alone, thanks to the help of your escrow account. Not sure what that is or what it covers? No worries! Read on to see what an escrow is and how it works.
What’s an escrow?
An escrow is a financial arrangement that involves an impartial third party who holds money during a transaction to ensure both parties fulfill their contractual obligations. Once the transaction has been completed, the third party transfers the funds from one party to another.
How does it work?
Typically, escrow is associated with real estate, and there are two main occurrences. When buying a house, you’ll likely need to put down earnest money to show your serious interest in a house. In this case, an escrow account is set up to protect both the buyer and the seller, allowing the money to safely be deposited after the transaction is completed. For example, if a house fails an inspection during a contingency period, you would be able to walk away without losing that earnest money—and without a fight to get your money back. You can also walk away with no penalty if the house doesn’t appraise. If you’re building instead of buying, escrow may be used to ensure the work is completed and signed off on before payment.
Once you’ve purchased your home, your lender may setup an escrow account for taxes. Each month, part of the payment you make is put into that account, which your lender then can use to pay your property taxes and insurance. Escrow accounts may also cover things like waste management services from the city or county and homeowner’s association fees, but check with your lender for a full list.
Your lender will analyze your account yearly to make sure they’re collecting the right amount. If they’re collecting too much, you’re entitled to an escrow refund, while you’ll be on the hook for the difference if they’re collecting too little. You may be given options to make a one-time payment or increase the amount of your monthly mortgage payment to make up for a shortage in your escrow account.
Why have an escrow?
Overall, the main purpose is to protect all parties in a transaction. During the buying process, escrow helps ensure that funds are only deposited once all the required conditions are met, like a home inspection or the completion of a punch list, which are the tasks that need to be completed before construction is considered finished. There’s also less risk of fraud because the money is held by a third party. Escrow accounts can even make things easier for you by handling fund disbursement or tax payments so you don’t have to. Note that escrow accounts may not be required, but you can request one. If you don’t have an escrow, you’ll need to be sure you’re setting aside funds for your property taxes throughout the year.
Benefits of using an escrow
Aside from the legal protection, escrow accounts can provide several additional benefits. By setting up an escrow account, you’re able to divide a larger insurance or tax bill into more manageable monthly payments. Sometimes adding an escrow account can also help you qualify for a lower interest rate or reduced closing costs. If you’re worried about remembering and paying all the new bills that come with homeownership, this can be convenient and a helpful way to avoid late fees.
Drawbacks of using an escrow
On the other hand, an escrow account isn’t necessarily the best choice for everyone. The biggest drawback is that estimates aren’t always correct, which may end up costing you more down the line. In addition to increasing your monthly mortgage payment, you may also have to pay additional service or maintenance fees, and these fees can add up fast. Lastly, if growing your money is a priority, most escrow accounts don’t earn interest.
Managing your escrow
If the drawbacks outweigh the benefits to you, you may consider managing the funds yourself, or self-escrowing. To do this, you’ll want to a separate account where you can set aside money to cover your property taxes and insurance premiums directly. This affords you more control over your money, allowing you to set up accounts that earn interest, like a high-yield savings or money market account (MMA), so you can grow your funds in addition to paying your bills.
Be aware, your loan type may require an escrow account. Moreover, you may be charged a cancelation fee to close an existing escrow account. If you already have an account, you’ll have to contact your lender to see if you qualify, and follow their steps to close the account.
When managing your own account, be sure to budget appropriately and keep up with your bills. Property taxes in Georgia are paid annually, typically around the end of the year. With holidays falling at the same time, you’ll want to plan ahead. Additionally, you don’t want to fall behind on your homeowner’s insurance—emergencies can strike at anytime and a lapse in coverage can impact you negatively.
What happens if your funds are mismanaged
Even if you aren’t self-escrowing, it’s incredibly important to stay up-to-date on your property taxes and insurance premiums. Unfortunately, mistakes can happen and your lender may miss a payment, causing a discrepancy. If you notice a mistake, contact your mortgage servicer immediately. You may also need to follow up with a notice of error. Depending on what bills they might have missed, you’ll also want to contact the tax office or your insurance carrier to ensure you can resolve the issue as soon as possible.
Other types of escrow
While escrow is most common with real estate, it can apply to any situation where funds pass from one party to another. One place you might not expect an escrow is with online transactions, especially more high-value items, like antiques, jewelry, or digital assets. Once the item has been received and the condition confirmed, the funds are dispensed to the seller. Escrow may also be used for transactions like business acquisitions, stock transactions, and even legal settlements, providing an extra layer of security for these transactions.
Key takeaways:
- Escrow is when a neutral party holds money during a financial transaction.
- An escrow is commonly associated with real estate but can also be used during stock transactions or business acquisitions.
- Escrow accounts are not mandatory with all mortgages, but you can request one or self-escrow.
Homeownership can be a lot of fun, but it comes with a lot of responsibilities. Thankfully, an escrow account can help you manage some of them, without any extra hassle. But even if your lender manages your escrow, don’t forget to keep an eye on your property taxes and insurance payments to ensure they’re being paid on time.
