What is an Escrow Account?

Escrow is a word that is unfamiliar to many people and can refer to several different pieces of a real estate transaction and property ownership. When you buy or sell a home in Washington State an escrow company will act as the neutral third party to hold all funds until all the terms of the contract have successfully been executed. An escrow account as it relates to landlords and tenants, can refer to the account where security deposit funds are held by the landlord to make sure they don’t get commingled with personal funds and remain available at the end of the lease term when they may need to be returned to the tenant.

An escrow account as it relates to a mortgage loan (sometimes called an impound account) is an account in which potentially your property taxes, homeowner’s insurance, private mortgage insurance, and/or flood insurance are held by your lender. You as the borrower do not have access to withdraw from this account, so it creates an easy way to prepay some of your property expenses.

How does it work? Here’s an example.

This is Todd’s monthly bill from his lender:

• $3,300 Principal and Interest on Mortgage

• $75 Homeowner’s Insurance

• $520 Property Taxes

• $310 Private Mortgage Insurance (PMI or MI)

• $4,205 Total Due Monthly

Todd makes one payment to his lender for the total of $4,205. (PITI – Principal, Interest, Taxes, & Insurance). His lender will pay the Principal and Interest ($3,300) toward his loan amount. The remaining Homeowner’s Insurance, Mortgage Insurance and Property Taxes ($905) will be put into the escrow account each month and held as a running balance to go toward each account as payments are due.

Typically, property taxes are a semi-annual expense and insurance can be paid monthly, quarterly, or annually. These are automated withdrawals handled by your lender, however you are ultimately responsible for making these payments, so make sure to review the escrow balance periodically on your mortgage statement to confirm your it is accurate. Your lender will keep a specified extra amount of funds in your escrow account in case of fluctuations to any of your tax or insurance bills. At the end of the year if your account balance exceeds the maximum amount specified for overages, your lender will issue you a refund of the remainder.

Below is a chart that shows a potential breakdown of payments from our scenario

Month Deposit Expenses Running Balance

January $905 PMI - $310 $595

February $905 PMI - $310 $1,190

March $905 PMI - $310 $1,785

April $905 PMI, Property Taxes - $3,120 -$430

May $905 PMI - $310 $165

June $905 PMI, Homeowners Insurance- $760 $310

What are the benefits? The main benefit for both the borrower and the lender is that the likelihood of the borrower defaulting on property tax payments or not having the property fully insured is significantly less with an escrow account. In our example, Todd only has to make one payment, once a month, and all of those individual expenses are taken care of.

Alternatives to an escrow account

Some borrowers prefer to pay their own property taxes, homeowner’s insurance, etc. If your lender allows it, this can be beneficial if you have these funds in an interest-bearing account, the stock market, etc. However, this leaves you as the borrower responsible for budgeting for the larger quarterly or annual payments rather than the smaller monthly payments.