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What is Escrow and How Does an Escrow Account Work?

When you’re looking into becoming a homeowner, one word you’ll hear a lot is escrow. The legal definition of escrow is to place (something) in custody or trust, but in essence, an escrow account is a holding account for the money involved in your real estate transaction. You can have escrow accounts before, during and after the sale.

Most real estate transactions involve an escrow account, both during the sale and then once the sale is complete you and your lender will often have an escrow account to handle tax and insurance payments. Unless you waive escrow, when you make your monthly mortgage payment, your lender will retain a portion of your payment for property taxes, PMI, homeowners insurance and other fees, which will go into the escrow account. When bills for those items (property tax bill, insurance premium) come due, your lender will go into the escrow account, remove whatever amounts are needed to pay those bills, and pay them on your behalf.

At the end of the year, your lender will catalog the escrow payments into the account and the payments out of the account. If your city or town increased your property tax rate and you didn’t increase your monthly mortgage payment, you may find yourself with a shortfall at the end of the year that you’ll need to pay up via a separate payment to your lender. If you’ve overpaid escrow, at the end of the year your lender may cut you a check, allow you to retain that amount in escrow for future expenses, or may let you apply that overage amount to your mortgage principal.

Can I waive escrow?

Yes, many lenders will allow buyers to waive escrow. When you “waive escrow”, you are agreeing to take on the responsibilities to pay amounts that would otherwise be paid via your lender through the escrow account. Instead of paying additional amounts to your lender each month for property taxes, you can elect to waive escrow and pay those amounts directly to your city, town or taxing entity. Same with your homeowners insurance – you can elect to pay your insurance for the year in one lump sum payment, instead of paying a bit each month to your lender’s escrow account.

Should I waive escrow?

Whether or not it makes sense for you to pay bills yourself which are generally paid via escrow is a personal decision. If you like to know exactly what you need to pay each month and don’t want the headache of worrying about taxes and paying at the right time, or having your insurance policy potentially lapse because you forgot to make a payment, then using escrow is probably the way to go. If you are in a profession where you get a hefty bonus at the end of the year and you would rather use that to pay your property taxes and insurance, and then pay less each month for your mortgage, then waiving escrow might work more in your favor.

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