What is escrow?

Learn more about this common term used when purchasing or selling real estate & what it means.

Escrow can carry two separate meanings when referring to real estate & while the term is frequently used, it can be confusing to homeowners with less experience in buying, selling, or carrying a mortgage. Here's a simple breakdown of what the term escrow can refer to in the closing process:

1) Escrow in terms of closing:

During the process of transferring a property from one party to another (for example, sale of the property), certain funds (such as earnest money) or items of value (such as deeds or finance documents) may be collected and held until all the conditions of a contract are fulfilled by both parties. The date by which these terms are typically resolved is called the closing date. Until closing, these funds and items of value are kept in a secure account managed by a third party (typically a title company, financial institution or real estate broker), until they can be released to the parties they are promised to. This account is called an escrow (you may sometimes hear this period referred to as being "in escrow"). 

2) Escrow in a mortgage payment: 

Not to be confused with the escrow during closing, your lender may create an escrow account when a buyer uses lender financing to purchase a home. This escrow is created for the purpose of paying the annual property tax and insurance premiums on the property and is funded by a portion of your mortgage payment. These funds are paid directly to the tax collector and insurer on your behalf by the lender each year and held "in escrow" up until that point.

Each year, the lender will review the escrow account to ensure it can sufficiently pay the next year's premium and send a copy of this to you, called an amortization statement/schedule. This statement will attempt to estimate the amount needed for next year's tax & interest premiums. Each month the lender will collect a portion of this projected amount (plus a set "cushion" amount) in addition to your principal and interest payments.

Because taxes & insurance premiums can fluctuate, when you carry an escrow with the lender, your mortgage payment could fluctuate as well. Not all loans will require the creation of an escrow when the buyer  meets certain criteria, but buyers who aren't required to hold escrow can still opt for this option.