What Is Escrow?

What is an escrow account?

Escrow accounts, sometimes called trust accounts or impound accounts, are a type of prepayment account. Escrow is most commonly used to hold funds intended to pay taxes, insurance premiums and related expenses.

Escrow balance is the amount in your escrow account at any given time to cover real estate taxes and insurance premiums when they are due.

Escrow accounts can be used for different purposes, but most people encounter them when a mortgage lender collects funds for monthly house payments and puts them into an escrow account. While escrow accounts are not always required, your lender might recommend one. Having an escrow account for taxes and insurance can help you avoid a large, unexpected bill at the end of the year.

One ConsumerAffairs reviewer in California was happy with how their escrow account was managed. “As I went through escrow, I was assigned to a specialist for each stage,” they said. “I felt I had a whole team helping me through my first home.”

Types of escrow accounts

There are two primary types of escrow accounts: pre-purchase and post-purchase.

Pre-purchase escrow

Pre-purchase escrow accounts are for earnest money. Earnest money is typically 1% to 3% of the home price, and it shows the seller you’re serious about the purchase. This money goes toward the down payment after purchase, but it is not always refunded if the sale falls through.

Post-purchase escrow

Post-purchase escrow accounts are for taxes and insurance payments. Your monthly mortgage statement will show an escrow line, which represents a portion of your estimated yearly insurance and tax expenses. This amount may change yearly, and it’s estimated by your lender based on the previous year's expenses plus two additional months. If you owe more than you’ve saved, you must pay the difference. If you put more in escrow than you end up needing, you get a refund.

» MORE: Does mortgage preapproval affect your credit score?

How does an escrow account work?

An escrow account works sort of like a savings account, but it’s managed by your mortgage servicer and doesn’t earn interest. You can think of an escrow account as a prepayment account used to cover the costs of homeowners insurance, taxes and other fees.

To be “in escrow” means that some amount of money or piece of property is temporarily controlled by a third party until a specified condition has been fulfilled, such as the closing of a deed.

» MORE: Homebuying checklist

Common escrow terms to know

It’s helpful to know some common terms associated with escrow:

• Advance: An escrow advance is any money put toward taxes or insurance premiums.
• Agent: An escrow agent is a third party (a person or an entity) that holds and manages assets, money and documents until a transaction is finalized.
• Balance: An escrow balance is the amount in your escrow account at any given time to cover taxes and premiums.
• Close of escrow: The close of escrow is when documents and payments are finalized.
• Disbursement: An escrow disbursement is when the funds are used to pay for charges and expenses.
• Earnest money: Earnest money is a good faith deposit from the buyer.

How much are escrow fees?

Escrow fees can vary depending on the state you’re in, your home’s price and the chosen escrow company.

“Escrow fees are related to the fee the chosen escrow company is charging to handle the escrow,” said Ken Sisson, a California real estate agent and associate broker with Coldwell Banker Realty. “They can vary, but usually you’ll see a flat rate fee in the $500 to $1,000 range, plus a cost of around $1.50 to $2 per thousand dollars of the price of the home.”

For example, a $500,000 home for sale could have the following escrow fees:

“If you’re located in an attorney state, you’ll have attorney fees in lieu of escrow fees,” said Sisson. Attorney states require an attorney to be present at the signing of the legal loan documents. Some attorney states are Connecticut, Delaware, Georgia, Massachusetts and South Carolina.

Bottom line

Escrow may seem like an added complication to the homebuying process, but it can provide valuable protection and peace of mind to both buyers and sellers. After you buy your dream home, an escrow account can make taxes and homeowners insurance easier to manage financially.