What is Escrow and How Does Escrow Work?

Learn more about escrow on a house and see how escrow works in 5 easy steps! Endpoint's team of closing specialists is here to help you.

The Starting Line

What is escrow? What does "in escrow" mean? In different markets, being “in escrow” can mean different things. For some, it’s the period of time between going under contract and reaching the closing table. In others, it’s an ongoing part of the monthly mortgage payment.

You may have heard the term “escrow” used in a variety of ways in relation to real estate, but what exactly is escrow and how does it apply to a home sale, purchase, or ownership scenario? Our guide answers all of your escrow-related questions so that you can better understand how it works and how a streamlined closing process can benefit you, whether you are buying or selling a home.

1. What is an escrow account and how does it work? What is an escrow on a house?

What is an escrow account and how does it work? What is escrow on a house? In order to answer these questions, we’ll look at a few of the uses and definitions related to the concept of escrow.

What does in escrow mean? What is escrow?

The definition of escrow is, essentially, the process of putting a third party in charge of documents or finances in order to ensure that timely payments are made and that all parties to a real estate transaction are protected.

What is escrow used for? What does an escrow do?

Escrow can be used for a variety of purposes during the home purchase and ownership process.

  1. Escrow during a purchase begins once a home goes under contract -- that is, once a buyer and seller have agreed to terms and signed a purchase agreement along with contingencies and addenda. 

This type of escrow account holds the Earnest Money Deposit (EMD), documents related to the transaction, and any other items needed to complete the purchase and sale of a home or property. That means that if the sale falls through, a neutral third party is holding the money involved until the financial details are completed. This protects everyone involved and ensures that the terms of the contract are upheld.

  1. Escrow during a term of ownership involves the third party collection of funds from each month’s mortgage payment in order to pay for large items like property taxes and homeowner’s insurance. Such escrow payments may be required by the mortgage lender in order to ensure that these obligations are met and that the home is not in danger of loss, or loss in value, due to unpaid taxes or uninsured damage.

What is an escrow payment? What does escrow cover?

What is escrow payment? In the case of escrow on a house, the escrow payment will be 1/12 of the estimated annual cost of required payments like property taxes and homeowner’s insurance. That means that the payment can vary according to insurance rates, property assessments, and other factors.

Approximately every six months, the escrow company will be billed for taxes and insurance premiums on the property. These will be paid from the money held in escrow. Required escrow payments may then be adjusted if the estimates were insufficient to cover the costs or a refund may be given if the estimates were too high, resulting in too much money withheld.

What is an escrow balance?

An escrow balance is the difference in the amount of money held in escrow at any given time of year and the amount required to pay property taxes and insurance premiums. 

  1. A negative balance or escrow shortage means that not enough funds were withheld each month, and the difference will be passed on to you. 
  2. A positive balance means that too much money was withheld, and the difference will be refunded to you.

2. How does escrow work?

Escrow works in a variety of ways, depending on where you are in the home purchase or ownership process.

How long is a house in escrow?

A house is generally in escrow from the time that it goes under contract until closing, when all of the obligations between buyer and seller have been fulfilled and the home’s deed is available for transfer. In most transactions, 30 days is sufficient for closing. However, in case of a cash sale, the process may be shorter, while a particularly complex sale may take significantly longer.

How long do I pay escrow on my mortgage?

Escrow payments on a mortgage depend on the requirements of the lender. In some cases, like VA or FHA loans or other low-interest scenarios, escrow payments will be required for the life of the loan, which can be as much as 30 years. Some conventional mortgages, on the other hand, do not require escrow payments.

3. Why would escrow not close?

There are many different reasons that an escrow would not close. Some examples include the buyer or seller holding up the process with delayed responses, wasting time, or refusing to cooperate. Other factors that may keep escrow from closing include an appraiser or appraisal review taking longer than expected. Home inspections that result in time-consuming repairs can also keep the escrow from closing in time.

4. Can a buyer back out during escrow?

Buyers can back out during escrow if they’re still within the agreed-upon time period and certain contingencies are not met. A buyer may back out for various reasons such as issues with financing, insufficient home inspection results, or troubles with the appraisal. If a buyer backs out during escrow when all contingencies are met, though, they may lose their earnest money deposit.

5. How much does escrow cost?

Escrow costs vary according to your local property tax costs and homeowner’s insurance premiums. One-twelfth of the cost of these payments will be added to your escrow account each month. 

Remember, these costs can go up if your property tax assessment rises, if your market becomes more desirable, or if, on the other hand, your market becomes more risky. You will generally find out your adjusted escrow costs once each year.

6. Do you have to pay escrow monthly?

Generally, escrow accounts are paid monthly as a form of forced savings for large, biannual tax and insurance payments.

Can I withdraw money from my escrow account?

No, you cannot withdraw money from your escrow account. The funds there are designated for payments to the local taxing authority and to your insurance company. In the event that you pay either of these bills directly, you may be eligible for reimbursement from the escrow account, depending on the circumstances and policies of the escrow company.

How much escrow is required at closing?

You will probably be required to pre-fund your escrow account at closing, depending on the time of year in relation to and the payment schedule of the local tax authority and your insurance company. This ensures that when a payment is due, there will be sufficient funds in the escrow account to cover it.

How can I reduce my escrow payment?

Your escrow payment may be reduced or eliminated in the following ways:

  1. Your property assessment and insurance premiums may go down, resulting in a lower biannual payment.
  2. You may refinance your home from a VA or FHA loan -- which requires escrow payments -- to a conventional which may not.
  3. You may request a waiver of your lender’s escrow requirement once you have paid your mortgage for twelve months with no late payments. 
  4. You may pay off your mortgage, eliminating your escrow withholding.

7. What does Escrow look like in your state?

Learn more about what the Escrow process looks like in your state.

  1. Arizona
  2. California
  3. Texas
  4. Washington