By Jennifer Tucker
November 11, 2022 | 4 Min. Read
When you’re ready to buy a home and apply for a mortgage, you’ll hear all sorts of new words—appraisal, assessment, amortization (and that’s just the start!). As you work your way through the glossary, you’ll stumble upon another important term: escrow.
Let’s look at escrow in the mortgage process to understand how it works and answer some frequently asked questions.
When you close on your mortgage, it’s likely your lender will set up what’s called an escrow account. You can think of it as a savings account. Each month when you make your mortgage payment, a portion of your payment is deposited into this account. The funds cover costs associated with home ownership, like property taxes, mortgage insurance, or homeowners’ insurance.
Having an escrow account can be helpful to homebuyers because it ensures you’re automatically saving for these expenses, and the payments will be made on time.
An escrow account is an easy way to manage your property taxes and insurance premiums. When you have an escrow account, you make one monthly payment that covers your mortgage principal plus the estimated cost of things like property taxes and insurance. It takes the guesswork out of saving for these expenses and ensures your payments are made on time.
Your mortgage lender will calculate escrow along with your monthly mortgage payment. Escrow is calculated by estimating costs for taxes or insurance premiums and adding these costs to your principal and interest payment. The result becomes your base monthly mortgage payment.
You can also use a free online calculator to calculate escrow. Marine Credit Union offers a variety of free budgeting and financial planning tools. Use our free online calculator to calculate your mortgage payment, including principal, interest, and common escrow costs.
When you close on a loan, your mortgage lender will open and manage your escrow account. They will act as your ‘escrow agent,’ handling your account and making payments from it.
There are two types of escrow accounts commonly used in the home-buying process: a real estate escrow account and a mortgage escrow account.
A real estate escrow account typically holds funds needed for the homebuying process, such as earnest money, down payment, closing costs, or other transaction costs. At closing, the escrow manager pays these costs and fees from your real estate escrow account.
A mortgage escrow account is typically opened at closing and lasts for the life of your loan. This account holds funds for things like property taxes and homeowners’ insurance. When these expenses are due, the escrow manager pays them from your mortgage escrow account.
When you get a mortgage, your lender will calculate your annual tax and insurance payments, divide the amount by 12, and add that amount to your monthly mortgage payment. Each month when you pay your mortgage, the escrow portion will be deposited into your escrow account. When your property taxes and insurance premiums are due, the lender will pay them from your escrow.
Lenders usually require an escrow account with your loan. They will manage the account for you and use the funds to pay property taxes and insurance payments on your behalf.
If your lender does not require an escrow account and you’re given a choice whether to open one, consider how disciplined you are with your finances and your ability to set aside funds for these annual expenses. If you’re not a good saver, it may be a good idea to have an escrow account.
Banks use the loan-to-value (LTV) ratio to determine if your loan will require an escrow account. If your mortgage amount represents 80% or less of the home’s value, you may be able to avoid escrow. Still, it may be wise to open an escrow account to ensure you’re automatically saving for tax and insurance payments and making these important payments on time.
Marine Credit Union can help you find the right mortgage loan to reach your goals. Keep your loan in the community. Get in touch with a Marine Credit Union lender today.