Escrow accounts hold funds for a specific purpose, with the most common types being related to real estate and property transactions. They are used to ensure property taxes and homeowner’s insurance are paid on time and in full, with monthly payments made into the account. Escrow accounts can also be established for other purposes, such as holding loan proceeds for construction until certain phases are completed. Homeowners should review their statements carefully for errors.
An escrow account is an account established to hold funds prior to disbursement for a particular purpose. The two most commonly known types of escrow accounts in the United States are related to real estate and property transactions. The former is set to hold funds, usually from the buyer of the property, until such time as the property is actually transferred, at which time the funds are disbursed. The second is established and maintained by a property’s mortgage lender. The owner makes regular payments into this account for property tax and homeowner’s insurance payments.
The escrow account maintained in conjunction with the property purchase is established and maintained by the buyer’s attorney in some jurisdictions, and by an escrow agent in others. When the buyer makes an offer to buy a property, the offer is accompanied by cash, which is held in the escrow account until the sale is finalized and the escrow is closed. Strict accounting of all funds is done at closing, including disposition of escrow funds.
When real estate is purchased, the owner assumes the obligation to pay property taxes in a timely manner. Also, most mortgage companies require the homeowner to purchase and maintain homeowner’s insurance on the property to protect against loss. If taxes are not paid when due, a tax lien can be placed on the home for back taxes, jeopardizing the mortgage company’s interest in the home. Similarly, if the homeowner’s insurance lapses and a loss occurs, the mortgage company’s investment is equally compromised. Therefore, it is in the interest of the mortgage company to ensure that the property tax and homeowner’s insurance are paid on time and in full.
To accomplish this, most mortgage companies will require the homeowner to make monthly payments into an escrow account from which taxes and insurance premiums will be paid. When the mortgage is first issued, the owner pays an amount & emdash; usually two months of payment of taxes and interest & emdash; after which regular monthly payments are made with the monthly mortgage payment. When the tax bill or insurance premium is due, the mortgage company makes the payment from the escrow account. An advantage of this type of agreement is that the owner does not have to worry about keeping track of those payments.
A particular advantage of paying taxes and insurance through an escrow account is that the payments, when due, can put a strain on a homeowner’s budget, as tax bills are generally due quarterly and insurance premiums of owners are generally paid annually. The escrow system allows money to accumulate in an intact account and frees the owner from having to come up with the funds to pay for insurance and taxes. One drawback of the escrow system is that escrowed funds generally do not pay interest to the owner, who technically owns the funds until they are disbursed.
Homeowners should also carefully review their monthly mortgage statements and periodic statements of escrow account activity. Errors in escrow accounts are not uncommon, especially when mortgages are transferred from one bank to another, and if errors are not caught early, there is often no recourse for the owner.
Trust accounts can sometimes be established for other purposes. For example, loan proceeds for the construction of a home will be held in escrow and disbursed once particular phases of construction are completed. The funds are held in escrow to assure the builder that they are actually available, as well as to ensure that the work is completed satisfactorily before the funds are released. In fact, whenever performance or payout is an issue, one option is to establish an escrow account in the custody of a trusted third party, which will be released upon satisfactory performance.
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