An escrow account can give a borrower piece of mind. Escrow accounts are holding accounts used to keep funds to pay an obligation. The most common use of an escrow account is on a mortgage, to pay taxes or insurance. The bank will add the monthly tax payment or insurance premium to the borrower’s monthly mortgage payment. When the taxes or insurance are due, the bank will make the payments directly.
The most common use of escrow accounts is for property taxes. The lender will contact your municipality to determine your monthly tax payment. It will then collect two to four months of payments at closing as a cushion. The monthly tax payment will be added to your monthly principal and interest payment. The lender will place the funds in your escrow account, which will be used to make your tax payments on a quarterly basis.
Another common use of escrow accounts is for homeowner's insurance. When you take out or renew your insurance policy, the bank collects the premium up front. It then adds the monthly premium to your mortgage payment. The funds go into your escrow account. The bank pays your new policy upon its yearly renewal.
Private Mortgage Insurance
Lenders require Private Mortgage Insurance (PMI) on loans where the borrower puts down less than 20 percent of the purchase price. Yearly PMI, on average, runs about one-half percent of your balance. In the case of a $200,000 loan, your yearly PMI is $1,000. The monthly payment of $83.33 is collected and placed in your escrow account.
Sometimes an escrow account is used for less common reasons. For example, if you have a construction line of credit and the line will expire before you finish, the rest of the funds may be held in escrow until you finish the project. Another example is an interest reserve account. If a borrower is considered a higher risk, the lender may require him to put money in escrow to cover the interest in the event of default. Essentially, an escrow account can be used to hold money in abeyance for a number of reasons.