The Ins and Outs of Escrow
If you have never owned a home, you likely have no idea what ‘escrow’ means, but have certainly heard the term tossed about in real estate circles. In a nutshell, the escrow agent is simply a third party that holds the money in trust between a lender and a borrower. Their role is to ensure that both parties agree to all the terms before the funds are released.
How Is Escrow Used In Real Estate?
As a safety net for most mortgages, lenders require you to open an escrow account. The funds in this account are appropriated for property tax and homeowners insurance. Because rates on both fronts aren’t fixed, you will often see the rates change. The escrow agent’s job is to make adjustments to your escrow account to cover these fluctuations. Your job is to make the determined monthly payment each month.
The reason the lender is so concerned with your income and property taxes is it affects them directly if you default. Homes with liens on them are difficult to sell. Also, if your home is not insured and a disaster ensues like a hurricane or a flood, the lender is stuck with the debt.
Why Is It Good?
For borrowers on a tighter income, it ensures a predictable payment each month, something you can budget for. The alternative is paying your insurance and property taxes in one lump sum. When you’re looking at thousands of dollars, it’s a hard pill to swallow and can affect your standard of living when payments are due.
It also allows you to put down a smaller down payment if that’s beneficial. The best part is it will get you a lower interest rate, which translates to a lot of savings over 30 years or so.
Why Is It Bad?
People who make large incomes will not mind the large payments. If they have investment knowledge, there are better ways they can invest their escrow money. In many states, escrow doesn’t even gain any interest! The problem with waving escrow is most lenders aren’t very comfortable with it. They would at the very minimum require a 20% down payment, which is quite lofty even if you’re doing well. In addition to that, you would likely see an increase in your interest rate.
Before waving escrow, it’s important to do your math. You have to look at how much extra a higher interest rate will cost you and weigh that against how much money you project earning if you invest the funds differently. This is of course given it’s fiscally sound for you to pay a higher down payment, you have to project how much money you can expect to make investing that elsewhere as well.
It’s important not be overwhelmed by the enormous amount of paperwork you will have to sign when you close escrow. Take your time, go over it thoroughly and make sure all the terms are fair. Once you’ve signed everything, the escrow officer will present you with a deed naming you as the owner. At this point you need to forward your down payment and closing costs, then your lender will wire your loan to the seller so they can get paid. Once these steps are completed it will finally be officially your home.
Can’t get enough of escrow? Learn more about what escrow is.