For many, an escrow account can be one of the most confusing pieces of a mortgage. Though they’re not always required, I believe they’re one of the most beneficial tools a person can have in their financial tool box. Once you understand what it is and how it works, it’s easy to see the benefits of utilizing one.
What is it?
Escrow is a separate account that you make monthly contributions to with your mortgage payment. The contributions are then used to pay property taxes and homeowners insurance. Part of your mortgage agreement is that you’re required to have homeowners insurance and pay property taxes.
What are the benefits?
By utilizing an escrow account, you can more easily budget for your taxes and homeowners insurance. If you didn’t have an escrow account, you would be required to make three lump sum payments each year: taxes in May and October, and your annual homeowners insurance. Your escrow account helps you set aside money month each month so when you’re payments are due, your lender handles sending the payments out for you.
How does it work?
Imagine your monthly payment consists of two buckets. In the first bucket you have your principal and interest payment. This payment goes to your lender. The second bucket includes your escrow items (taxes and insurance). This payment gets set aside into your escrow account. Once your taxes and insurance are due your lender handles paying them out of your escrow account for you.