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The Importance of Escrow Accounts in Mortgage Transactions

Updated on August 9, 2014

Understand what escrow is and how it is used in mortgage transactions can be confusing. However, an escrow account plays an important part when buying a home. Essentially, escrow is considered to be money, securities or property that is handled by a neutral third party. For the most part, escrow is generally used during real estate transactions. The neutral third party managing the account is considered an escrow agent. The escrow agent holds on to assets during the time that the two parties are working through finalizing a deal. An escrow agent is generally a real estate agent, real estate attorney or escrow company.

When a buyer decides to make an offer on a particular property, the buyer is expected to back up the offer by putting up some cash once the seller decides to accept the buyers offer. When a buyer sends an offer to purchase a piece of property, the offer also states the buyer's intent to purchase the property after certain conditions being met.

From a seller's perspective, some of these conditions include the buyer being able to secure a mortgage loan. In the conditions it may state that there may be a delay if the buyer must first sell an existing property to pay off the current mortgage before obtaining another loan. Other conditions may be that the buyer insists that certain repairs must be completed first.

Once both parties agree on the conditions outlined, then the cash is given to an escrow agent and placed in a separate account. If the conditions required are met then the money will go to the seller. However, if the conditions haven't been met then the money goes back to the buyer. The neutral third party is necessary to help prevent any disagreements and lawsuit on who will receive the escrow money. Also keep in mind that there is an escrow fee for the services of the escrow agent.

In some cases, the escrow money is used by mortgage companies to ensure proper payments of property tax and homeowner's insurance. This is when 1/12 of the cost of annual property tax and homeowner's insurance premiums are added on to the monthly mortgage payment. Again, this is to ensure that those two important aspects to buying a home get paid.

If a homeowner fails to pay the annual property tax then the government has the right to seize the home to sell in order to pay off the taxes owed. This may leave the mortgage company in a tight spot. Therefore the escrow money is used to ensure that the taxes are paid and the mortgage company isn't out thousands of dollars.

Mortgage companies are also concerned with homeowner's insurance. Anything can happen from natural disasters such as flooding and tornadoes to the home catching on fire. Having the extra money go into escrow each month will help cover the cost of the homeowner's insurance premiums. If the property goes without insurance and a disaster occurs, once again this can cost a mortgage company thousands of dollars.

Having the mortgage company pay the cost of homeowner's insurance and property taxes makes with escrow money, makes it easier on the homeowner. If the rates go up, the mortgage company may ask the buyer to pay the difference or raise the monthly mortgage payment the following year to cover the extra expense. Each year the homeowner will receive a statement of the money placed in an escrow account and how it was used.

A downside to mortgage company escrow accounts is that if the lender decides to change servicing agents. This may result in the property taxes and homeowner's insurance premium going unpaid or being paid late. For the most part the buyer is oblivious to the problem until the moment it occurs. This can be frustrating and very time-consuming to get sorted out.

So as you can see setting up escrow accounts are important in mortgage transactions. Whether it is an agreement between the buyer and seller or extra money each month to make sure the two important bills to owning a home gets paid, having an escrow account is actually helpful to the buyer as well as the seller or mortgage company.

© 2014 L Sarhan

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    • LindaSarhan profile imageAUTHOR

      L Sarhan 

      4 years ago

      Sorry you went through that. This article is written from a United States perspective but escrow is always a good idea regardless of the country; I think so anyway.

    • profile image

      Kieran Gracie 

      4 years ago

      Very useful information here, Linda. I once contracted to buy a property 'off plan' in Marbella, Spain but the developer had yet to secure the building license from the local council. Luckily, knowing about escrow accounts and against the loud squeals from the seller's attorney, I insisted on my 10% deposit being placed in escrow. Initially the local Spanish attorney even tried to say that such a thing did not/could not exist under Spanish law! Of course you can guess the rest - no license was forthcoming so, after waiting about 6 months, my patience ran out and I demanded the return of my deposit. And I got all my money back, unlike a number of other investors who I know lost their deposits.

      Good Hub, and thank you. Voted up accordingly.

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