“We’re in escrow!” is a common exclamation from hopeful homebuyers, but for those who’ve never bought a house, you might be asking, “what does that actually mean?”
You’ll also be asked if you want an escrow account when it comes to your mortgage — in both purchase and refinancing situations.
This article will not only tell you all about escrow, from both a homebuying and refinancing perspective, but also tell you what you need to know about California escrow, in particular. Sound like a plan? Let’s dive in!
What is an escrow account?
Simply put, an escrow account is a financial account held by an uninterested third party.
When you’re buying a home, you deposit your earnest money into it — usually 3% of your purchase price. This shows the property’s sellers your good faith in going through with the deal. That’s usually the point when people excitedly say, “we’re in escrow!” You also deposit the remainder of your down payment into this account and your lender deposits your loan amount there. All the money related to your purchase stays in that account, where no one can touch it, until the deal is finalized or terminated.
When you’re applying for a mortgage, an escrow account (also called an “impound account”) is an account set up by your lender to pay for your homeowner’s insurance and property taxes when these housing expenses come due during the course of a given year. Each month, you pay a portion of your annual tax and insurance costs and this money is held in escrow for you to be distributed on your behalf when the bills come due.
What should you know about an escrow account?
- It makes tax and insurance payments easier. An escrow account is a way for you to pay your property taxes and homeowner’s insurance dues in a timely, convenient manner. it is a great way to budget for your yearly property taxes and homeowner’s insurance expenses and you can voluntarily request your lender to establish one for you at no additional cost.
- They can be required. Typically, lenders will require an escrow account when your loan-to-value ratio exceeds 80 percent (aka you put less than 20 percent down on the home). In California, lenders can’t require escrow accounts unless your loan-to-value ratio exceeds 90 percent.
- There are safeguards in place. If your lender requires an escrow account, it must follow all of the Real Estate Settlement Procedures Act (RESPA) guidelines. RESPA limits the amount lenders can collect to establish an escrow account. A lender can only collect the amount necessary to pay for your homeowners insurance and property taxes, plus two additional months to establish a “cushion”. In addition, your servicer is required to make all of your property tax and homeowner’s insurance payments on time. If it fails to pay your bills when they are due, the lender must cover any late fees or interest that result from the failure to make the payments. Additionally, if at any time the lender finds that the balance in your account is higher than allowed by federal law, it must refund the excess money to you within 30 days.
And there you have it — all the essential things you need to know about escrow accounts when it comes to buying or refinancing a home. If you have any further questions, feel free to chat with one of our licensed Loan Specialist. If you’re ready to investigate mortgages rates or apply for pre-approval, you can do so completely online.