What Does My Escrow Balance Pay?
As you begin the mortgage process, you'll hear words like "escrow" and "escrow balance" with an increasing frequency. To help you become the savviest homebuyer possible, let's break down the escrow process to help you understand what an escrow account is, and what the escrow balance pays for throughout the homebuying process as well as the life of your mortgage.
What is Escrow?
Escrow is a third-party account that holds funds in safekeeping as property changes hands. During the homebuying process, you may be asked for a deposit once a seller accepts your offer. This small payment will be used to demonstrate good faith in your intention to proceed with the house purchase. These funds will be placed "in escrow" which means they won't be given to the buyer. Rather, the funds will be held by an impartial third party until the house purchase is negotiated and completed. Escrow ensures that all of the parties in the homebuying process get what they need and that money doesn't go to a party that hasn't fulfilled the terms of purchase.
You might also hear the term "escrow" used differently. Where your mortgage is concerned, an escrow account (also known as "impounds" or "reserves") is a holding account that places a portion of your mortgage payment in reserve to pay certain bills associated with your property and mortgage.
What Does My Escrow Balance Pay For?
Your escrow balance with your mortgage lender pays your homeowners insurance, hazard insurance, mortgage insurance (if applicable), and taxes. The due date of these bills is completely managed by your lender and your escrow account works as a holding account of sorts to ensure that these bills are paid to the appropriate parties and in a timely manner.
During the mortgage process, it may be possible to opt-out of impounds. When lenders use an escrow account balance to hold funds for tax and insurance payments, they'll know that these bills will be paid automatically and on time, thus protecting their investment in your debt. When you opt out of impounds, the risk for the lender increases as if you default on your mortgage.
How Can I Monitor My Escrow Account Balance?
During the first year of a mortgage, over-payments in a mortgage escrow account will be difficult to assess. The ideal time to review your escrow balance is after the first of the year when your lender will be able to show you your current balance and all payments that have been made for the previous year. While lenders are required to keep a certain level of funds in reserve in your escrow account, there's no need for excess funds to be held. Lenders automatically send refund checks to homeowners each year when there is an overage. You may also receive a notice asking if you'd prefer a refund check or to apply the overage in your escrow balance to your mortgage principal.
Be sure to ask your real estate agent and lender any questions you may have about managing an impounds account for years to come. And don't forget to review this process again, especially with impound accounts, should you choose to refinance down the line.