Escrow?! The E-word Explained

The financial industry is made up of a whole bunch of jargon.

Those who work in the banking sector don’t think twice when they hear terms like mutual fund or diversification. But for the layperson, navigating this specialized vernacular can be difficult.

Escrow is one member of the banking-speak family that might befuddle some. You’re probably familiar with it if you’ve purchased a house or completed a similar transaction. Otherwise, unless you’re an avid student of finance or an industry professional, the word might not ring a bell.

If you’re leaning towards the latter, not to fear. Here we’ll explain the “e-word” in plain language and demonstrate the role it plays in mortgage contracts.

What is Escrow?

Escrow is an account held by a third party to validate a transaction. It’s used in major purchases to ensure both the buyer and seller are sticking to their end of the deal.

For example: Say you have a vendor selling parts to a buyer in a different country. The buyer needs to ensure the goods arrive in his hands in working condition, and the seller needs to make sure the buyer is able to pay for the product.

In this case, an escrow account benefits both parties. The buyer can make his payment in an escrow account instead of giving money directly the seller, meaning that if the parts are found to be out of order, the escrow company will refund him his money. The seller, on the other hand, benefits in that he won’t need to get rid of his product until the buyer has provided payment.

Escrow acts as an intermediary ensuring all terms of an agreement have been met.

Why do I Have an Escrow Account as Part of My Mortgage?

You’ve likely encountered the term “escrow” if you have, or are planning to, purchase a house. Escrow accounts attached to mortgages make the payment process easier for both lenders and borrowers. Here’s how.

A mortgage payment is made up of principal and interest. But when you make your monthly payment, you’re also paying for homeowners’ insurance and property taxes.

Mortgage contracts often require that escrow accounts are created to house the funds needed to pay your insurance and property taxes, while the principal and interest money goes directly to your lender.

This way, you’re paying your insurance and taxes without having to think about it or forking over a lump sum when payments come due. It also gives your lender peace of mind knowing that these expenses are being paid.

Lenders will estimate how much you’ll need for escrow each year. This number is based on property tax information and the type of homeowners’ insurance you have. You’ll receive a refund if you’ve overpaid; but, you could also need to pay money in if your escrow estimate is too low. The latter is known as an escrow shortage.

Opening the Door to Homeownership

There you have it: A brief explanation of escrow and its function in the world of finance.

Still got questions? Shoot us a line.

Sunrise Banks offers mortgage loan and refinancing options. We’re also happy to assist with home equity loans and lines of credit. Visit our mortgage page for more information.