Understanding Escrow and Why It’s Important
A kind of good-faith, surety tool
The term escrow has been in use for more than a century as a financial tool to facilitate the exchange of money and documents between real estate buyers, sellers and their financiers. In simple terms, it’s a service or account provided by a neutral third-party, such as an escrow company, lawyer or notary, mortgage lender or servicer, or title agent. Interestingly though, the term escrow has many different purposes:- Mortgage servicers remit a portion of your monthly house payment into escrow, also known as a “mortgage impound account,’’ to cover your home’s property taxes, private mortgage insurance and hazard insurance.
- In some cases, homeowners’ association fees are escrowed.
- Landlords place renters’ security deposits in escrow.
- Housing courts frequently use escrow in the settlement of tenant-landlord disputes.
- Escrow also is deployed for payment of general contractors and subcontractors on construction projects.
And in a digital era in which more property sales, lending applications and decisions, and fund transfers occur remotely via the internet, it helps to understand the role escrow plays in our global economy.
Escrow keeps deals organized and on track
Banks and credit unions typically do not charge fees to set or administer escrow accounts for mortgage or construction loans they originate.These third parties collect and hold funds, deeds, title papers and other vital documents, until buyer and seller have fulfilled all the obligations under their agreement. Escrow offers these benefits:
- That all parties involved uphold the terms they agreed upon
- That the paperwork is kept in order
- That the funds for each party is accessible
Many states mandate escrow agents to be licensed, including Massachusetts and Rhode Island. Escrow agents, too, are required to stay at arm’s length in transactions, to avoid impropriety. For instance, a real estate agent or lawyer representing you in a transaction cannot oversee your escrow.
Escrow accounts take on different forms
While many consumers know or have encountered escrow accounts and services when buying or selling a home, what you may not know is how frequently and widespread escrow is applied to a cross-section of industries and transactions.- Real Estate Sales Escrow: You’ve made a firm offer to buy your dream home, backed up with an earnest-money deposit that’s immediately put into an escrow account where it remains until closing. Later, if you change your mind and back out of the deal, you may forfeit all or part of your escrow deposit, depending on terms of your purchase contract. If the seller backs out, your earnest deposit is returned to you.
- Mortgage Escrow: If you’ve ever financed your home with a mortgage, your lender or mortgage servicer – the entity assigned to collect your monthly payment – most likely established an escrow account to hold a portion of your house payment earmarked to cover your property taxes, association fees, and mortgage- and hazard-insurance premiums. Your mortgage escrow balance may fluctuate annually, depending on increases or decreases in your property-tax assessment, owner-association fees and insurance coverages. If your balance falls into an “escrow deficit,’’ your lender or servicer will raise the escrow portion of your house payment to adequately cover those outlays. Conversely, if your mortgage escrow balance reaches surplus because your lender/servicer overestimated your escrow payouts, you can either keep the surplus in escrow or request the overage be redeemed back to you. Banks and credit unions are not required to pay interest on escrow deposits.
- Renters Escrow: Landlords usually insist tenants advance one or more months of rent, or that pet owners put up a deposit as security against damage or undue wear and tear. Those deposits are placed in escrow, to be returned in full in most cases to tenants when they move or lease expires.
- Massachusetts is among at least 10 states that require landlords accrue interest on tenants’ security deposits. The tenant is entitled to either 5% interest or whatever lesser amount is received from the bank where the deposit has been held, if you live in the apartment for at least one year.
- Escrow also can be vital in resolving disputes between tenants and landlords. With oversight from a court or judge, rents from aggrieved tenants are temporarily placed in escrow until the dispute, typically involving the need for serious repairs to a property, is resolved.
- Construction Escrow: Set up like other kinds of escrow accounts, construction escrow is focused on holding and disbursing borrowed construction loan proceeds to general contractors and subcontractors on building projects. Construction escrows usually are administered by title agencies, who aside from paying vendors for their work, watch out for lien filings from unpaid vendors or other parties that could disrupt the project.
Waiving an escrow account
Though escrow accounts are useful tools, they can have limited shelf lives. For instance, once your home equity reaches a certain threshold, you can ask your mortgage lender or servicer to waive the escrow requirement. Large mortgage down payments of 20% percent or more also may qualify you for a waiver.Doing so, however, means you are solely responsible for paying in full and on time your property taxes, insurance and other escrowed obligations. If you fail to keep up, your lender or servicer can revoke the escrow waiver.
Now that you know the importance of escrow for buying and owning a home, let Bristol County Savings Bank’s mortgage advisors share with you how our other mortgage products and services can put you on a solid path to home ownership in Massachusetts or Rhode Island.