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 accounts can be used for different purposes, but most people encounter them in the real estate context when a mortgage lender collects funds with your monthly house payment and puts them into an escrow account.

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.

Types of escrow accounts

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

• Pre-purchase escrow 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 for taxes and insurance: 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 is estimated by your lender based on the previous year's expenses plus two additional months. If you owe more than you have saved, you must pay the difference. If you put more in escrow than you end up needing, you get a refund.

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.

» 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.

• An escrow advance is any funds put toward taxes or insurance premiums.
• An escrow disbursement is when the funds are used to pay for charges and expenses.

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. I felt I had a whole team helping me through my first home,” they said.

» MORE: Homebuying checklist

How much are escrow fees?

“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:

• $1,000 flat fee
• $1,000 additional fee (500 x $2)
• Total: $2,000 in escrow fees

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

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.