Escrow is a legal arrangement in which a third party temporarily holds money or property until a particular condition has been met. It is commonly used in real estate transactions to protect both the buyer and the seller. An escrow account is established by the mortgage lender to hold funds for taxes and homeowners insurance. The account is funded each month as part of the total monthly payment, and the lender uses it to make property tax and insurance payments on behalf of the homeowner.
Escrow accounts are beneficial as they allow for monthly payments toward insurance and taxes instead of a large lump sum, and they ensure that payments are made on time to third parties, such as county taxing authorities and insurance companies.
The escrow bank account is managed by the lender, and it is the bank or mortgage company’s responsibility to pay the bills on time. The lender is liable for penalties should there be a missed or late payment. Whether or not an escrow account is required depends on the type of loan and the borrower’s financial profile. While some lenders may allow borrowers to pay taxes and insurance on their own, others may require an escrow account, especially if the borrower has less than 20% equity as a buyer or if the loan is guaranteed by the FHA or VA.