When two parties in an agreement or contract have financial dealings, they may set up an escrow account that's monitored or governed by an independent third party, known as an escrow agent. When certain terms of the contract have been fulfilled, the agent will release funds in accordance with the guidelines established in the contract.
When you have a mortgage, the lender may require you to have an escrow account to pay your property taxes and homeowners insurance. Your monthly payment will consist of interest, principal and an escrow payment.
If your annual tax payments are $1,000 and your annual insurance payments are $1,500, you would pay $208.33 per month to the escrow account, ($1,000 + $1,500 = $2,500/12 = $208.33). When the tax bill and insurance premiums are due, the lender will pay them.
A mortgage lender will perform an escrow analysis once a year to make sure the correct amount of money is being allocated to the escrow account. When the lender receives the tax bill and insurance statement, the payments will be made to the appropriate institutions even if there are not enough funds in the escrow account. A shortage is created and your mortgage payment is increased to cover the shortage and prevent any more in the future.
When you hire a contractor to do home repairs for an insurance claim, the lender may request that the funds be put in escrow until the contractor completes the work. Sometimes a percentage of the funds are released after a corresponding percentage of the work has been done until the project has been completed.
After signing a contract for a home, you may be required to put up earnest money, which shows your commitment to the deal. The earnest money is put toward the purchase price at the closing. This money is kept in an escrow account until the deal is finalized. The language in the contract will determine if you get your money back if the deal is not completed.
In certain situations an escrow account could pay interest. If you can find an account that pays interest, you may want to invest the money as opposed to having your lender pay your taxes and insurance. Escrow account requirements may be waived if you pay a fee. If you have 20 percent equity in your home, escrow accounts can be waived but your interest rate might be higher.