Escrow in Relation to Home Loans
What is the meaning of Escrow?
The actual definition of escrow, in law, is a bond, deed, or document held by a third party -- and this bond, deed, or document will take effect only when specific conditions have been met. Alternatively, escrow can be an account set up by a broker for holding funds on behalf of the broker or some other person until the completion or termination of a specified transaction. During a home sale, escrow is the organization or use of a third party to hold funds on behalf of the buyer/seller, who ensures the buyer and seller meet specified requirements of the sale prior to releasing the funds. The escrow service is not the buyer or seller and has no interest in the transaction or preference on the buyer or seller. Once the sale is finalized, the borrower may be requested to keep an escrow account with the lender to pay other obligations.
What is paid in escrow?
An escrow account can be required or requested by your lender and is an account that is not managed by you, the borrower. This escrow account is used by the lender to make payments for any insurance on your home, such as homeowner’s insurance, and your property taxes or homeowner’s association fees, if applicable.
The payments are collected in one consolidated payment which is the monthly mortgage amount and the fees paid in escrow are paid when they are due by the third party person or company managing the account. The amount that goes toward escrow is determined by an escrow analysis which is provided by your lender on a yearly basis. However, the analysis can be provided upon request at another time. It is important to note that the amount varies by year.
Why do you need an escrow account?
An escrow account is managed by a third party company or person and is used to pay insurances, property taxes and homeowners association fees if they apply and is frequently required or requested by lenders.
The person or company managing the account pays those fees for you when they are due and it is done through the monthly mortgage payments paid by you. This will help evade any late payments, lapses in homeowner’s coverage, or liens on your home. In some cases, lenders will offer a lower interest rate on your mortgage which can add up to a large sum over the years.
What makes escrow go up? Why would there be an escrow shortage?
Escrow is collected with your monthly mortgage payments and the amount allocated to the escrow account is based on the yearly escrow analysis provided by your lender. This document has been overestimated for some but is frequently underestimated and this is what would cause an escrow shortage. Escrow can go up yearly and the variant is typically impacted by increases in property value or any changes in policies or insurance companies. In other words, an escrow shortage is what happens when there are not enough funds in your escrow account to cover the amount required to pay your bills and is a result of changes not applied to the escrow analysis.