An escrow account is a financial instrument created in order to store money collected by a lender to pay for property taxes and hazard insurance when they become due by a third party. A lender will usually require monthly escrow payments to ensure that they have enough funds to pay for taxes and insurance. Since an escrow account is often used in the sale of a home, lenders will require these payments to guarantee that their collateral is secure.
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Paying an escrow account is important in the event that certain disasters or circumstances occur. For example, if your home burned down in a fire and you had not paid the hazard insurance premium, the lender would not be able to recoup the loss. The first year of hazard insurance will usually need to be paid up front. In a different situation, if you fail to pay your property taxes then the government can potentially foreclose on your property. The insurance and tax amounts will vary depending on what city and state your property is located.
As an example, if your hazard insurance rate is $1,800 a year, then you would need to put $150 into your escrow account each month to cover that. Likewise, if your property taxes cost $2,400 a year, you would need to put $200 a month in escrow to pay that bill for total of $350 a month. These numbers can have a big impact onyour overall monthly mortgage payment so it’s important that you factor them in when looking at buying a house. Having reserves is always encouraged in case of emergencies as well.
For most borrowers, escrow accounts are straightforward and easy to understand because the lender sets them up and handles them. Escrows are not always required, so most times there is an option to cover the insurance and taxes on your own, it just depends on your specific situation.
Looking for more information on buying a home? Our Mortgage 101 Handbook is the ultimate guide for First Time Home Buyers.