Having an Escrow Account: A Boon or a Bane?

When you’re buying a home, you’ll likely hear the term “escrow” thrown around. Let’s explore the world of escrow and determine if it’s a good fit for you. But what is escrow exactly, and is it something you should choose?

What is Escrow?

Escrow is essentially a financial holding pattern. It’s like a safe deposit box where money is held until certain conditions are met. In the context of buying a home, escrow is used to protect both the buyer and the seller. The buyer’s deposit is held in escrow until the closing, and the seller’s proceeds are held in escrow until the buyer fulfills all the purchase agreement terms.

Escrow Accounts: Two Flavors

There are two main types of escrow accounts:

• Escrow for Home Buying: This account holds the buyer’s deposit, ensuring it goes to the right party based on the sale agreement. If the deal falls through due to the buyer’s fault, the seller usually gets to keep the deposit. If the purchase is successful, the deposit becomes part of the buyer’s down payment.
• Escrow for Taxes and Insurance: After you buy a home, your mortgage lender sets up an escrow account to pay your property taxes and homeowners insurance. Each month, a portion of your mortgage payment goes into this account. When the tax and insurance bills are due, the lender uses the escrow funds to pay them.

Benefits of Having an Escrow Account

• Peace of Mind: Knowing that your tax and insurance bills are taken care of automatically is a huge stress reliever. You don’t have to worry about missing a payment or incurring late fees.
• Convenience: Having just one monthly mortgage payment to manage simplifies your budget and eliminates the need to juggle multiple bills.
• Protection for Lenders: Lenders have a vested interest in ensuring your property taxes and insurance are paid. Unpaid taxes can lead to liens on your home, and lapsed insurance can leave your home vulnerable to significant financial loss. By having an escrow account, lenders can ensure these bills are paid on time.

Drawbacks of Having an Escrow Account

• Higher Monthly Payments: Your escrow account is funded through your monthly mortgage payment, making it slightly higher than it would be without escrow. However, this is offset by the convenience of not having to pay large sums for taxes and insurance in one go.
• Potential for Inaccurate Estimates: The amount needed for your escrow depends on your property taxes and homeowners insurance costs, which can change yearly. Your servicer estimates the amount based on the previous year’s bills, but unexpected changes, like a property tax reassessment, can lead to a shortage in your escrow account. This could result in a higher monthly payment to make up for the difference.
• Limited Coverage: Escrow accounts typically don’t cover all homeownership expenses like utility bills or homeowners association fees. You’ll need to manage these payments separately.

Should You Opt for Escrow?

The decision to open an escrow account or not is based on your preferences and financial circumstances. Escrow is a good option if you prefer the ease and security that come with automated bill payments. However, choosing not to use escrow might be something to think about if you’re confident handling your own money and want to possibly save some.

The Bottom Line

During house sales, escrow is essential for safeguarding both buyers and sellers. It also offers a convenient way to manage your property taxes and insurance. Although there are some disadvantages, escrow is a useful tool for many homeowners because the advantages frequently exceed the disadvantages.

Additional Considerations

• Escrow Requirements: Certain loans, like FHA loans, require escrow accounts. Conventional loans typically require escrow if you’re putting down less than 20%.
• Escrow Waivers: In some cases, you may be able to opt out of having an escrow account. However, this usually requires a higher down payment and a strong credit profile.
• Escrow Management: Your mortgage servicer manages your escrow account and sends you annual statements detailing the funds held and payments made.

Making the Right Choice

The choice to open an escrow account or not is ultimately a personal one. Before making a decision, carefully weigh the advantages and disadvantages and take your unique financial situation into account.