In a mortgage context, escrows refer to funds that are set aside and managed by a neutral third party (usually a title company or an escrow company) to cover certain expenses related to the property. These expenses typically include property taxes and homeowners insurance premiums. Escrows act as a safeguard for both the lender and the borrower to ensure that these essential costs are paid on time and that the property remains adequately protected.
Here’s how escrows work in a mortgage:
- Property Taxes: When you have an escrow account, a portion of your monthly mortgage payment is set aside to cover your property taxes. Instead of paying property taxes directly to the local government yourself, the lender manages this aspect. When the property taxes are due, the lender uses the funds in the escrow account to pay them on your behalf.
- Homeowners Insurance: Escrows also cover homeowners insurance premiums. Homeowners insurance protects the property against damage from fire, theft, accidents, and other covered events. Like with property taxes, a portion of your monthly mortgage payment goes into the escrow account to ensure that the insurance premium is paid when it’s due.
- Escrow Analysis: At least once a year, the lender performs an escrow analysis to review the amounts collected and paid from the escrow account. If there’s a shortage (insufficient funds to cover upcoming payments) or a surplus (extra funds beyond what’s needed), adjustments may be made to your monthly mortgage payment to ensure that the escrow account remains adequately funded.
The main benefits of having an escrow account are as follows:
- Simplified Budgeting: With escrows, you don’t have to worry about coming up with large lump sums for property taxes and insurance payments. It’s spread out over your monthly mortgage payments, making budgeting more manageable.
- Assurance for the Lender: Lenders want to ensure that the property remains protected and that property taxes are paid on time to prevent tax liens on the property.
- Protection for the Borrower: Escrows offer peace of mind to the borrower, knowing that their essential property-related expenses are taken care of, and they won’t be hit with unexpected financial burdens.
It’s important to note that not all mortgages require escrow accounts. In some cases, borrowers may choose to handle property taxes and insurance payments independently. However, many lenders do require escrow accounts, especially for certain loan types or if the borrower has a smaller down payment, to mitigate the risk of non-payment of these critical expenses. Always carefully review your mortgage terms to understand whether escrows are a requirement in your specific situation.