What is escrow? Escrow is when two or more people or parties enter into a legal agreement that provides for the placement with a third party for safekeeping certain properties, instruments, or assets, and the release of these properties, instruments, or assets is contingent on the performance or fulfillment of certain conditions or acts. An escrow account is an account that is specifically set up only to disburse funds for a specific reason or use. In real estate investing and other transactions of this type, escrow accounts are normally used to hold funds that are intended for insurance premiums and real estate taxes that have been paid in advance and can only be released for these intended purposes.
In real estate, escrow collections are amounts that have been collected from the borrower by the loan provider to be put into escrow for specific expenses. These expenses are hazard homeowners insurance, property taxes, mortgage insurance, and any other amounts that are paid on a annual or semi-annual basis. When money is released from an escrow account for the intended use, this is called an escrow disbursement.
Using escrow for these types of expenses protects both the borrower and the lender. The borrower gets peace of mind knowing that the lender can only access the funds for the intended purpose. This guarantees that the lender will not take the monthly payments for these expenses and not apply them towards the intended use. The lender can rest easy knowing that the borrower can not remove the funds or spend the money on other things. Both parties have an assurance that these bills are being met. The lender may be especially interested in the insurance payments, because if something happens to the house and the insurance premiums have not been met, then the lender stands to loose a lot. If the property taxes are not paid, the property may be seized for back taxes, costing either the lender or borrower more money. This is why it is important to use escrow for monthly payments of this type.
Certain expenses are paid every year or twice a year. Most of the time borrowers pay one sixth or one twelfth of these expenses on a monthly basis, and these funds are put into escrow until the expense comes due. Always beware of anyone who refuses to put these payments into an escrow account. Any legitimate real estate investor or lender will be more than willing to put these amounts into escrow, and if they seem uncomfortable with this that should be a red flag concerning at least their business practices, if not their business ethics. An escrow account should specify that it is an escrow account. The funds in an escrow account always belong to the borrower until the expense the account is set up for is paid.
It is important to use escrow so that both parties are protected, and the funds are held for specific expenses. This protects against fraud, as well as guaranteeing that certain expenses like property taxes and insurance payments are made on time to protect the lender’s interest in the property. The home buyer has the security of knowing that the money will go exactly where it should, and can not be removed for any other reason.