Understanding Escrow: A Key Step toward Homeownership

If you are a first-time homebuyer, there is a mountain of mortgage knowledge to obtain in a relatively short amount of time. Aside from interest rates, appraisals, and inspections, you are going to have to wrap your brain around understanding escrow somewhere before signing on that dotted line. Ruoff is here to help not only get you to closing day, but assist you every step of the way, and understanding escrow is one of these key steps.

What is Escrow? 

Escrow describes a financial arrangement and good-faith measure whereby money is held by a third party on behalf of a potential buyer and seller that are in the process of completing a financial transaction. It works to show that the buyer in the transaction plans to uphold their part of the contract during the time in which the transaction is in motion but not yet settled. It is necessary to understand how this step works as escrow plays a big role in the homebuying process. That being said, you might hear escrow spoken about in two ways depending on how far along in the process you are. 

Escrow for the Homebuyer 

This is the account that holds the earnest money on behalf of the homebuyer and seller while waiting on the finalization of the sale. 

Escrow for the Homeowner 

After a closing of the sale, this is the account that holds a portion of the mortgage payment intended to pay the property’s taxes and insurance on behalf of both the homeowner and the lender. 

Is Having an Escrow Account a Requirement? 

Like many things in life, the not-so-clear-cut answer is “it depends.” Some lenders will require an escrow account in order to protect their own interests and ensure both the property taxes and homeowner’s insurance are paid in full and on time. This requirement also may come into play should a buyer put less than the commonplace twenty percent down at the forefront of a sale.  

Should a buyer meet the standard down payment, though, select lenders may leave this additional safety net up to the discretion of the homeowner. A word of caution to those considering foregoing this additional layer of convenience: with all the spinning plates each month, sometimes the easiest way to make sure all the bills get paid is to put someone else in charge of them. An escrow account helps homeowners spin a couple less plates, helping to ensure none of them get dropped. 

Why Might Someone Choose Not to Open an Escrow Account? 

Homebuyers who prefer to be in greater control of their finances and track every payment themselves might choose not to open an escrow account to handle those semi-annual tax payments and insurance premiums. Folks who are on a fixed income and do not wish to encounter a potential escrow shortage (which may be difficult to cover at certain times of the year) may also wish to budget for these tax and insurance payments themselves. This may feel like a safer, more precise way to proceed instead of using an escrow account to handle these payments on their behalf. 

What Is the Best Choice for Me? 

Deciding whether or not to pay tax and insurance expenses out of an escrow account can be a difficult decision to make. That being said, this arrangement can sometimes be altered if you are in good standing with your lender and are up-to-date with all tax payments and have not experienced a lapse in homeowner’s insurance coverage. 

Following the first five years of mortgage payments, buyers may have the option to cancel the escrow account if the unpaid balance of the loan is less than 80% of the original value of the property and there are no delinquent payments. This allowance varies from lender to lender, though, and some banks may have more rigid stipulations when closing an escrow account if they permit it at all. 

Additionally, if a buyer elected not to set up an escrow account at a mortgage’s onset, they may be able to open one following closing. Buyers interested in this option will need to contact their tax authority and insurance company in order to do so, and it may take a little more time to organize than it would have during the homebuying process. 

While not the biggest step involved in the homebuying process, understanding what escrow is and how it works is still an essential piece of purchasing any home. Like any large life decision, though, it is important to feel knowledgeable about the decision as a whole and make a fully informed choice. Have more questions? Contact one of our Ruoff loan officers for more in-depth answers to your concerns.