The definition of escrow is: “A financial arrangement where a third party holds and regulates payment of the funds required for two parties involved in a given transaction.” (escrow.com)
I like to define escrow in a simpler way: escrow means go-between.
If you own a home, you must pay taxes and insurance. In most cases, you don’t directly pay your insurance company or the county for your homeowner’s insurance and property taxes. Most people have their mortgage or home loan company pay it for them. The company that you make your mortgage payments to acts as a go-between. They “escrow” your taxes and insurance. It breaks down like this:
- You make your mortgage payment.
- The mortgage company receives your mortgage payment.
- The mortgage company takes a portion of your mortgage payment and places it in a separate account.
- Insurance or taxes come due and send the bill to the mortgage company.
- The mortgage company uses the money they have put in the separate account to pay the insurance and tax bill.
This example of escrow can help you understand not only what it means, but how it is practically used.
If you’re buying a home or selling a home, there are two main parties involved in the transaction–the buyer and the seller. In most cases the exchange of money and property between the buyer and seller happens in phases. In order for the transaction to happen smoothly throughout each stage, an “escrow” company is hired. Here is how it typically looks:
- Buyer and seller agree to the terms of the sale (on a contract).
- Buyer shows commitment to the agreement by giving some money (called “earnest money”) to the escrow company to hold.
- Buyer inspects the home to ensure they want to buy it.
- If all goes well during the inspection, the buyer works on getting their funds together (most often with a home loan) to finalize the purchase and delivers funds to the escrow company.
- The escrow company verifies these funds are in accordance with the contract terms and facilitates the exchange of money and property to the needed parties.
This example is very different from the first, however the concept is still the same. There was a third party acting as a go-between.
So, what are mortgage escrow payments? It depends. If it is part of regular monthly home loan payments, see example #1. If it’s being referenced in the sale of real property, see example #2.
Either way, the general understanding of a “third party go-between” helps in properly answering the question.
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