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Escrow is a type of account used to stow money for an upcoming home purchase. It can also be used for future property taxes and insurance costs on a home you already own. Depending on your lender, you could use an escrow account both upfront and over the entire course of your loan.
Here’s what you need to know about escrow:
- What is escrow?
- How does escrow work?
- Escrow types
- What escrow accounts do
- What escrow doesn’t cover
- Pros and cons of escrow
- Escrow example
- What is an escrow fee?
- How long do you pay escrow?
- Are escrow accounts required?
What is escrow?
A buyer and seller may create an escrow account with a neutral third party to pay for certain expenses and avoid payment disputes.
For example, in real estate transactions, escrow agents collect earnest money and deposit it into an escrow account until closing.
How does escrow work?
Escrow works in one of two ways:
- To hold funds, such as an earnest money deposit, during a real estate transaction.
- To hold funds owed for annual housing expenses, such as property taxes.
During a real estate transaction, escrow provides financial protection for the buyer and seller should the transaction fall through. The purchase agreement states how much your monthly escrow payments will be and when the escrow company will disburse the funds.
Your monthly escrow payment to your mortgage lender will cover a portion of your:
- Property taxes
- Homeowners insurance
- Other insurance premiums (such as flood insurance)
- Mortgage insurance (if applicable)
When it comes time to pay your tax and insurance bills, your mortgage lender will pull the funds from the escrow account and pay the bills for you.
Learn: 30 Mortgage Terms to Know: Ultimate Glossary for Homebuyers
Escrow types
Most people associate escrow payments with a mortgage, but there are a few other situations where escrow may apply.
Real estate
Whether you buy a home with cash or a mortgage, most real estate transactions involve an escrow service to finalize the sale.
During the homebuying process, the seller usually uses a title company or an attorney to collect earnest money from the buyer and hold it in an escrow account until closing. Your real estate agent may also recommend an escrow service.
If you have certain contingencies in place that aren’t met, you might be able to receive your earnest money deposit back from the escrow provider instead of hoping the seller will refund the true amount.
Likewise, escrow helps ensure the seller receives the earnest money if the buyer backs out of the deal after certain deadlines have passed.
Taxes and insurance
Most mortgage lenders require monthly escrow payments to cover property taxes, homeowners insurance, and private mortgage insurance.
Your mortgage servicer estimates the annual cost of your expenses requiring escrow, and you pay a one-twelfth of the total amount each month. For example, an annual $1,200 insurance premium would require a $100 payment.
Your escrow agent disburses the funds annually when the appropriate bill comes due. After you pay off your mortgage deed, you receive any excess balance as a refund.
Stock
Investors and company executives may receive escrowed shares during mergers and acquisitions as an incentive to remain a shareholder during the transition.
You cannot sell the shares while they are in the escrow account. However, you can sell them once the shares settle and exit escrow.
Online sales
Online marketplaces may hold funds in escrow for the buyer and seller. For example, the buyer pays for the purchase in full but the seller won’t receive the proceeds until the item is delivered.
Cross-border transactions and freelance platforms may also use escrow accounts.
Security deposits
You may also need to make a refundable security deposit in escrow for services like staying at a vacation home, renting an apartment, or signing up for utilities.
What escrow accounts do
Escrow accounts have two different functions depending on when they come into play.
Before closing: Hold your earnest money
Once you find a home and put in an offer, you’ll give the seller what’s called an earnest money deposit. This is a good faith payment — one the seller gets to keep if you back out of the deal or violate your contract. An earnest money deposit typically amounts to 1% to 3% the home’s price.
If the seller accepts your offer, that earnest money deposit will be held in an escrow account for safekeeping until you either close on the home or back out of the transaction. If you do close on the home, the money will go toward your closing costs.
Escrow costs are just one of the many expenses you’ll face as a homebuyer. To lower your overall monthly expenses, make sure to shop around for great mortgage rates. You can find prequalified rates easily with Credible — and it only takes a few minutes.
After closing: Pay taxes and insurance
Another type of escrow you may encounter is “reverse account escrow.” This escrow comes into play after your home purchase is complete — and in perpetuity while you own the property.
Put simply, these escrow accounts are used to store a portion of your monthly mortgage payments. Once your property taxes and homeowners insurance premiums come due, your loan servicer will use the account balance to pay them off.
After you apply for a mortgage, your lender should give you a loan estimate that breaks down the four portions of your monthly payment: principal, interest, taxes, and insurance. This will give you an idea of how much will be withheld for escrow and how much will go toward paying off your loan each month.
If the analysis shows they’re short — or could be close to it — they may increase how much you pay into escrow each month. This would mean a higher monthly payment, too. (If the analysis shows they’re over-funding your escrow account, you could get a refund!)
Learn More: How to Lower Your Monthly Mortgage Payment
What escrow doesn’t cover
Escrow can be a handy tool in planning for the larger costs of homeownership. But be careful — it won’t cover everything.
There are many other costs of homeownership to think about, too. Take a look below to see what’s covered by escrow. Here are the advantages and disadvantages of escrow payments. When buying a home, you’ll likely make an earnest money deposit into an escrow account. This deposit is usually between 1% to 3% of the purchase price, but can be higher in some cases. So, on a $350,000 home, you can expect to put down at least $3,500 (1%) with your offer, in addition to your down payment. This gives you a monthly escrow payment of $350. At closing, your lender will likely require you to pay two months of escrow reserves upfront — in this case, $700. Also, keep in mind that your monthly escrow payment may adjust as your taxes and insurance premiums change. However, if you have a fixed interest rate, your mortgage payment will remain the same. Escrow fees can vary based on your location and escrow company, but you can expect to pay between 1% to 2% of the purchase price. Depending on the purchase agreement, either party may pay the entire cost or split the expense. Most mortgage lenders require paying escrow for the life of your loan. If you have private mortgage insurance premiums, you can request to cancel those payments once you reach 20% equity. Most home loans come with escrow requirements. Though these will make your monthly payment higher nominally, they really just spread the cost of your taxes and insurance out over time. They also prevent you from falling behind on your payment deadlines and eliminate some of the hassle that comes with homeownership (you don’t have to keep track of those deadlines by yourself). If you’re shopping around for a home loan, be sure to compare multiple lenders before settling on a rate. Credible streamlines the home loan process and makes comparing multiple lenders easy — you can see your prequalified rates from our partner lenders in the table below in just a few minutes. Josh Patoka contributed to the reporting for this article.
Expense Covered by escrow?
Property tax Yes
Homeowners insurance premiums Yes
Earnest money deposit Yes
Utility bills No
HOA dues No
Supplemental taxes No
Down payment No
Closing costs No
Pros and cons of escrow
Pros of escrow
Cons of escrow
Escrow example
What is an escrow fee?
How long do you pay escrow?
Are escrow accounts required?
