Escrow is a legal process where a third party holds and disburses money to the buyer and seller. Escrow agents act as a neutral intermediary for homeowners and homebuyers, and “escrow” is a common mortgage term you’ll hear throughout most real estate transactions.

Learn more about the escrow meaning and how the process works, so you know what to expect when you’re ready to buy a home.

What is Escrow?

The escrow process is a legal process where funds are collected and held by a neutral third party who disburses those funds on behalf of two other parties. An escrow agent manages the escrow, ensuring everyone receives their funds when the agreed-upon conditions are met.

An escrow on a mortgage is a common way to bridge the gap between homeowners and homebuyers. The mortgage escrow process helps prevent delays and legal issues related to real estate transactions, ensuring a smooth sale.

 

Most real estate transactions involve an escrow account and agent, but escrow accounts are also used for large purchases like vehicles and rare items like art and jewelry. Certain real estate transactions, like all-cash deals and some VA (Veterans Affairs) loans, don’t require an escrow account.

How Escrow Works When Buying a Home

If you are thinking about buying a house in the near future, an escrow account will probably be involved in the transaction. The first time you’ll use an escrow account is when you make an earnest money deposit, which demonstrates your intent to purchase the property. You’ll need to send this money to the lawyer or the house title/escrow company, then the escrow agent will hold it on behalf of the seller. 

Earnest money can be refunded if the deal falls through for a valid reason per the contract. If you back out without a valid reason, you’ll likely lose your earnest money deposit. The due diligence fee typically goes directly to the seller, unlike earnest money which is held by an escrow agent. Due diligence deposits are also different because they’re non-refundable. These deposits aren’t required upon conditional approval.

Earnest money is held and released by the escrow agent if the contract is terminated for a valid reason. If the deal goes through, earnest money is usually applied to closing costs at the end of the sale.

If a home sale falls through, the homebuyer can recover their earnest money deposit. Due diligence deposits are non-refundable.

What Is a Mortgage Escrow Account?

After closing, your escrow agent will disburse funds from the escrow account to the seller, agents, and other parties. You become the legal owner of the home, and the lender pays off your old mortgage and sets up your mortgage escrow account.

The funds in your mortgage escrow account will be used to cover property taxes and homeowners insurance. You may receive a refund check if there are excess funds in your escrow account.

Your lender manages your escrow account over the life of the loan, collecting a portion of each monthly mortgage payment and disbursing those funds for property taxes and homeowners insurance. This process ensures your bills are paid on time, so you can enjoy the benefits of homeownership without the hassle.

Pros and Cons of an Escrow Account

Review the pros and cons of using an escrow account during the homebuying process. 

Pros

  • Homeowners don’t have to worry about taxes and insurance. With an escrow account, funds are collected and disbursed for property taxes and homeowners insurance throughout the year. As a homeowner, an escrow account means you don’t have to worry about making lump sum payments at the end of the year.
  • Homebuyers’ deposits are protected if a sale falls through. If the transaction falls through because of a valid reason specified in the contract, homebuyers can get a refund for their earnest money deposit.
  • Lenders can ensure property taxes and insurance are paid. By collecting a portion of each mortgage payment in an escrow account, lenders can ensure homeowners are making property tax and homeowners insurance payments on time.

Cons

  • Homebuyers may have to contribute a significant amount. When you’re purchasing a home using an escrow account, you have to make earnest money and due diligence deposits, which can quickly add up. Due diligence deposits aren’t refundable in the event the sale falls through.
  • Homeowners’ mortgages appear higher. Since a portion of each mortgage payment goes toward insurance and taxes, homeowners have to make a larger monthly mortgage payment.
  • No credit card, no rewards. Homeowners can’t use credit cards to pay property taxes and insurance, which could mean missing out on rewards.
  • Lenders have to pay additional overhead expenses. Lenders often have to pay additional fees to use escrow accounts, and more staff is required to manage the accounts.

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How Escrow Affects Your Monthly Mortgage Payment 

Your monthly mortgage typically includes principal and interest (P&I). With an escrow account, you’re making payments toward the PITI (Principal, Interest, Taxes, Insurance) total, which means your monthly mortgage payment will be higher. The taxes and insurance portion of your mortgage payment will be held in an escrow account.

Escrow payments can change over time as the costs of property taxes and homeowners insurance fluctuate. Lenders typically perform an escrow analysis at least once a year. This annual escrow analysis ensures your escrow account has enough funds to cover property taxes and insurance, and may result in a refund in the event of a surplus or an increase to your monthly mortgage bill.

Get Help Understanding Escrow and Your Home Loan Options 

If you’re thinking about buying a home, it’s important to consider the different loan options and how escrow on a mortgage can impact your loan. Understanding the meaning of escrow, as well as relevant benefits and drawbacks, can help you prepare for your next home purchase.

At Griffin Funding, we have experience working with a wide variety of home loans. We offer tools like the Griffin Gold app and our free closing cost calculator, which can help you better budget for buying a home. 

Contact us today to learn more about our loan options or get started online and begin the pre-approval process.

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Frequently Asked Questions

Is an escrow account required for a mortgage?

Escrow accounts are often required for a mortgage, but that’s not always the case. All-cash deals, conventional loans with a large enough down payment, and some VA loans may not require an escrow account.

Can escrow payments change over time?

Yes, escrow payments can change over time as a result of annual escrow analyses. A surplus of funds can result in a refund, or your escrow payments can increase if the cost of property taxes and homeowners insurance increase.

Who owns the money in an escrow account?

An escrow agent manages the money in an escrow account, ensuring funds are properly disbursed to the buyer and seller. After closing, your mortgage servicer will manage your escrow account to cover property taxes and homeowners insurance.

Bill Lyons is the Founder, CEO & President of Griffin Funding. Founded in 2013, Griffin Funding is a national boutique mortgage lender focusing on delivering 5-star service to its clients. Mr. Lyons has 24 years of experience in the mortgage business. Lyons is seen as an industry leader and expert in real estate finance. Lyons has been featured in Forbes, Inc., Wall Street Journal, HousingWire, and more. As a member of the Mortgage Bankers Association, Lyons is able to keep up with important changes in the industry to deliver the most value to Griffin's clients. Under Lyons' leadership, Griffin Funding has made the Inc. 5000 fastest-growing companies list five times in its 12 years in business.