During a real estate transaction there are two types of escrow accounts: a real estate escrow account and a mortgage escrow account. When purchasing a property, you will need to familiarize yourself with both.
Real Estate Escrow Accounts
A real estate escrow account is where most purchase transactions begin. After your offer is accepted the next step is depositing earnest money (the initial deposit on the sales contract) into a bank account managed by a third-party to the transaction. This pre-negotiated sum of money will sit in the escrow account as good faith prior to the closing of the purchase transaction. The money will then be applied to the closing costs when the transaction is consummated.
What is the transaction is terminated?
If, for some reason, the transaction does not find its way to the closing table, the money held in escrow can be:
- In a case where the seller is unable to perform or the transaction is terminated due to mutual agreed upon circumstances or contingencies (home inspection issues, appraised value is low) the money can be refunded to the buyer with no penalty.
- In a case where the buyer is unable to perform (cannot obtain financing outside of a contingency, etc.) the money can be rewarded to the seller.
If the money is to be awarded to the seller due to a buyer’s negligence a mediation process can take place. This process blocks the seller from moving forward in any other transaction on that property until the mediation is complete.
Mortgage Escrow Accounts
A mortgage escrow account (sometimes referred to as an impound account depending on location) serves a very different purpose than that of a real estate escrow account. Aside from your monthly mortgage payment, there are several other costs that are due over the course of the year (including but not limited to):
- Property Taxes
- Homeowners insurance
- Flood Insurance (if in a flood zone)
A mortgage escrow account allows you to pay 1/12 of the annual payment each month. Then, when your payment is due your mortgage servicer makes the payment on your behalf. This type of escrow account makes paying bills easier by consolidating all property related expenses into one payment. Additionally, mortgage lenders enjoy when escrow accounts are implemented as it mitigates the risk of a borrower accidentally missing a tax or insurance payment. Escrow accounts requirement vary program to program:
FHA Loans: Always required
Conventional Loans: Required when the LTV exceeds 80%
Non-QM: Required when the LTV exceeds 80% (exceptions do apply)
VA: Not required by the VA, but typically required by the lender
Should you have any questions about escrow accounts reach out to one of our loan officers, they are here to help!