Understanding all the terms and processes of mortgages when buying a home can be a little overwhelming; especially for first time home buyers.  One of the most mysterious and recurring terms that gets thrown around with every offer is escrow and knowing the benefits and purposes of the escrow account will make your life easier and help you better track the finances of your home buying decision.

An escrow account is an account that is used to collect and hold funds for mortgage related expenses like property taxes, homeowner’s insurance premiums and other charges that may be associated with your home purchase where prompt and guaranteed payment of these bills is required to keep the home.  Most lenders require an escrow account that is maintained by the lender if less than 20% is put down on a home.  Real estate taxes and insurance premiums must be paid and paid on time.  Missing a tax payment could create a lien against your property and missing insurance premiums could result in the cancellation of your insurance policy.  Both of these results could lead to a lender dropping your mortgage.

The benefits of maintaining an escrow account, which many mortgage companies do for you, is that it will help you manage your budget, ensure that your home is protected and basically give you peace of mind.  Not having to make lump sum payments for insurance and taxes is a benefit to some people, while others are more budget savvy and would prefer to earn their own interest on this money.  In addition, when a lender maintains your escrow account your payments will be on time and there will be no laps in coverage due to late payments. 

When an escrow account is handled by the lender, the amount going to escrow is incorporated into your monthly mortgage payment.  Each month’s mortgage payment includes your principle, interest and money for taxes and insurance that is placed in escrow.  This is commonly referred to as PITI (principle, interest, taxes and insurance).  This does raise your monthly mortgage payment by the amount of taxes and insurance due on your property, but if you did not pay taxes and insurance with the mortgage, you would be paying out of pocket for these expenses any ways.
Do you have to have an escrow account? Most lenders will require an escrow account for borrower’s that own less than 20% of their home. 

However, after you have paid off enough of your mortgage you can remove PMI and PITI and handle your own tax payments and insurance payments.  Bearing in mind of course, that should a payment be late, you may lose your mortgage and more importantly if your insurance should laps and you were struck by tragedy like fire or flood, you would have to continue to pay your mortgage on a house that no longer exists. 

Hopefully this sheds some light on the elusive escrow mystery.  Escrow accounts protect both buyers and lenders by making certain that taxes and insurances are maintained on the home or property.