When you're going through the home buying process you may repeatedly hear the definition "escrow account." If these words are confusing to you then don't worry; it's easy to sort out.
Escrow Account Defined in Simple Terms
An escrow account is a deposit account that is created by a third party, usually an escrow agent, to hold in trust valuable assets that are tied to a transaction process on behalf of the transacting parties. In mortgage transactions, money is deposited in an escrow account by a homeowner for purposes of fulfilling the recurring debt obligations attached to a home.
The use of an escrow account in mortgage transactions is a procedural requirement that safeguards a lender's interests in a mortgaged property. The escrow account serves as the lender's platform for guaranteeing the prompt payments of any recurring liabilities by a homeowner. Such liabilities include property taxes, lease payments, and homeowner's insurance premiums. Escrow accounts are regulated by both at the federal and state governments.
Escrow Account Regulations
The federal government regulates escrow accounts through the Real Estate Settlement Procedures Act. RESPA primarily protects you from exploitation by your lender. Some of the core provisions of RESPA include:
- It limits the amount of money a lender can require you hold in an escrow account for payments (such as insurance and taxes).
- It requires a lender to submit an initial and annual statement about your escrow account.
- The lender cannot arbitrarily dictate the amounts that you will be required to deposit to an escrow account.
Refer to the U.S. Department of Housing and Urban Development (HUD) settlement cost booklet to determine if your lender's recommended deposits are reasonable.
Different states have different regulations for escrow accounts. Scrutinize your state's regulations as well to determine the legal compliance of your lender's terms and conditions for an escrow account.
How Exactly Does Escrow Work?
As the borrower, you bear the responsibility of depositing the monthly installments for the liabilities or debts attached on your home to an escrow account as they become due. The lender then transfers the amounts to the respective accounts to settle the underlying liabilities or debts attached to your home.
Escrow Disbursements
The money in an escrow account that is used to settle your recurring homeowner's bills effectively becomes an escrow disbursement. You will not be liable to any penalties that may arise out of late conveyance of the escrow disbursements by your mortgage lender. Such penalties are automatically transferred to the lender or the company that services your mortgage since it is their responsibility to manage your escrow account.
Cushion Payments
Sometimes you may be required to deposit more money each month than what is actually due to cover the bills. This extra amount is called a cushion. If you fail to pay into your escrow account one month, then that cushion will cover that month's bills. Respected and reliable lenders, however, do not generally demand large amount of cushions. Some lenders even pay interest to the borrower for money sitting in an escrow account.
Escrow Analysis
Escrow analysis is a periodic review of an escrow account that is undertaken to gauge if the deposits committed to your escrow account are sufficient to cover the outstanding monthly bills in relation to fluctuations to the amounts of the bills. The escrow analysis allows for appropriate adjustments to be made to either increase or reduce the monthly installments to match the prevailing billing amounts. Lenders typically analyze escrow accounts on an annual basis.
Filing Disputes
You have the legal rights to file a dispute should you be of the opinion that your lender's recommended deposits to an escrow account are unreasonably high. The first step involves making a written request to your lender. The lender is obliged to respond on the basis of the RESPA regulations within 20 days and resolve the written request in 60 days. Proceed to the next step and file a complaint with HUD in the event that you fail to reach a satisfactory agreement with your lender.
