Escrow is a term thrown around a lot, but what does it really mean when it comes to having a mortgage? It is often over-complicated, so here is an easy way to remember it. Most lenders require you to open an Escrow Account. When you pay your mortgage, you send one lump sum amount to the lender and the lender does two things with it. The majority goes to the house, principal and interest. A much smaller amount goes into escrow. I like to think of this as a savings account the bank holds in trust for you. Then, every year when your insurance bill and your tax bill come due, the lender pays those two bills for you out of that account. It is their legal duty to pay those two bills since they are collecting the money from you. An Escrow Account is a great way for you not to have to worry about remembering when to pay those two bills and you don’t have to come out of pocket thousands of dollars at once when they come due.
If your lender requires you to hold money in an Escrow Account, which most do, you may be wondering why. Regarding your Homeowner’s Insurance, lenders want to make sure the house is adequately protected by insurance. They have a lot of money invested in the home through the loan, so it is vital that there is proper coverage on the collateral. As for the tax bill, the lender does not want the house to get foreclosed on for missed taxes. The lender will make sure that tax bill is always paid so a tax sale is avoided and the lender stays in first lien position on the home.
You should always be able to get an accounting of what is currently in your Escrow Account. You may be one of the lucky ones that receives a check back once the tax and insurance bills are paid for the year. If you sell your home and there is still money in that Escrow Account, you will receive that back as, as stated before, it is your money that the lender is holding in trust for you.
Now that you see how simple the concept of escrow as it pertains to a mortgage, you can rest easy!