The word "escrow" appears repeatedly in real estate transactions, sometimes referring to different things. During the home purchase, escrow is the neutral third party holding funds and documents until all conditions are met. After closing, an escrow account is where your lender collects money for property taxes and insurance. Understanding both uses helps you navigate the process confidently.
Escrow During the Home Purchase
When your offer is accepted, you enter the escrow period—the time between contract signing and closing. An escrow company or title company acts as a neutral intermediary, holding your earnest money deposit and coordinating the various parties and documents needed to close.
Your earnest money goes directly to the escrow holder, not the seller. If the transaction closes, these funds apply toward your down payment. If it falls through for a reason covered by your contingencies (failed inspection, financing denial), you get your earnest money back. The escrow holder follows the contract terms to determine who gets the money in various scenarios.
The escrow company coordinates with your lender, the seller's representatives, and the title company to ensure all conditions are met before closing: loan approval, clear title, required inspections, and necessary documents. They prepare the closing statement showing all debits and credits for both parties.
At closing, the escrow holder disburses funds: paying off the seller's existing mortgage, delivering proceeds to the seller, paying various service providers, and ensuring the deed is recorded. This neutral coordination protects both parties from the other acting in bad faith.
Escrow Accounts After Closing
Most mortgage lenders require an escrow account (also called impound account) to collect funds for property taxes and homeowner's insurance. Instead of you paying these large bills directly, you make monthly deposits into escrow. The lender then pays the bills when due.
Your monthly mortgage payment includes four components (PITI): Principal, Interest, Taxes, and Insurance. The taxes and insurance portions go into your escrow account, which the lender manages on your behalf.
Lenders require escrow because they have an interest in your property staying insured and tax-current. Unpaid property taxes can result in liens that take priority over the mortgage. Lapsed insurance leaves the collateral unprotected. By collecting and paying these bills, lenders reduce their risk.
Escrow analysis happens annually. Your lender reviews expected tax and insurance costs for the coming year, compares it to your escrow balance and payment, and adjusts your monthly amount if needed. If costs rise, your payment increases. If there's a shortage, you might pay a lump sum or spread it over the year. If there's an overage (rare), you'll receive a refund.
Some borrowers prefer to pay taxes and insurance directly rather than through escrow. This is sometimes possible with a larger down payment (typically 20%+) and may come with a small rate increase. The advantage is controlling your own money; the disadvantage is responsibility for remembering and budgeting for these large periodic bills.
Understanding escrow helps you calculate your true monthly payment—principal and interest alone don't tell the full story of your housing cost.