What Is Real Estate Escrow and How Should You Use It?

When purchasing real estate, it is often necessary to open and use an escrow account.  At times, this can seem like giving your money to a faceless bank with no real idea what you’re paying for.  Read on to understand what an escrow account is and how to use it properly.

By definition, an escrow account is an arrangement where something is stored until an agreed upon action is performed.  For example, a sum of money could be held until a job is completed, then transferred into the worker’s account once the job is done.  In real estate, an escrow account is generally used for settlement costs, property taxes and hazard insurance.

Neither taxes nor insurance are included in the mortgage or interest payments, so home buyers may not include these in their calculations of annual payments.  Because of this, many banks require home buyers to maintain an escrow account in order to approve the loan.  If it’s not required, it’s often offered as an optional benefit.

Whether having this account is required or not, it is generally a good idea.  Rather than facing one large annual payment, escrow accounts ask you to deposit a much smaller amount every month, which will be used to pay the large sum when it is due.

The determination of how much you will contribute every month is calculated by a projection of what your annual taxes and insurance will cost.  Whatever your total annual amount will be, it is divided by 12, and you pay that amount each month.  Most escrow agreements require regular re-assessments of these calculations in a process called escrow analysis.  For homes, this is generally done each year.

Because the contributions are the result of predictions, it is possible, and in fact likely, that the predicted amount will be off in some way.  It is possible that you will contribute more than is necessary to pay the taxes and insurance.  However, the extra money you contributed is still yours, and you can determine what is to be done with that money when you first set up the escrow account.  One option is to receive a refund if there is a particular amount remaining after all balances have been paid.  Another is to keep the extra money in the account to reduce the following year’s payments.  Regardless of your preference, be sure your escrow agreement clearly outlines the procedure if extra money is in the escrow account.

By maintaining an escrow account with a trusted institution, you ensure that the funds needed to pay settlement costs, taxes and insurance are available at the appropriate time.  Using a company like Fidelity National Title Agency enables you to be confident that your money is handled properly and any questions you have about your escrow account are answered accurately.