What is Escrow in a Mortgage and How Does it Work?

escrow in a mortgage
Moshe Farber
23, Jan 2023

If you’re looking to purchase a home, the whole process can seem complex and confusing, especially when understanding financing terms and concepts like mortgage escrow. However, understanding what escrow is and how it works can help you make the best decision for your financial future.

Escrow is a type of fund holding that provides homebuyers with an additional layer of protection when taking out a mortgage to purchase a house. It can benefit you if you are a first-time homebuyer, as it helps ensure that all payments related to the house, such as taxes and insurance premiums, are made on time.

To help homebuyers like yourself understand mortgage escrow, let’s break down exactly what it is and how it works.

What Does Escrow Mean in Simple Terms?

Simply put, escrow is a financial arrangement between a lender and borrower that involves holding funds in an account until specific conditions are met before they are released. The purpose of escrow is to protect both the home buyer and seller during the transaction by ensuring that each obligation or requirement is fulfilled before any payments are exchanged.

In a mortgage escrow, the lender will collect money from the borrower (in this case, the homebuyer) to settle payments associated with purchasing a house. Usually collected monthly, this money is then held in an escrow account and will be divided into two:

  • One part goes toward paying the mortgage, including principal and interest
  • The other part goes toward paying for property taxes, insurance premiums, and additional fees related to the home purchase

When the time comes to pay these bills, the lender will use their collected funds from the escrow account to ensure that everything is paid on time and in full.

By having an escrow or impound account, not only are buyers protected from any potential default or delinquency on their loan payments, but it also ensures that both parties in the transaction feel secure about the purchase of the house.

How Does Escrow Work?

In a typical real estate transaction, the buyer and seller will agree on a set of conditions that must be met before the sale can be completed. Once everything has been agreed upon and all parties have signed off on it, the buyer will deposit money into an escrow account to cover any potential expenses or payments associated with the purchase. In turn, the seller will deposit the deed of the house into the escrow account until all conditions have been met.

At this point, the lender or escrow agent will hold on to the funds and property until all conditions are fulfilled. They will be responsible for ensuring that all terms and conditions are met. They will also oversee the transfer of funds from the buyer to the seller and record any documents related to the sale, such as deeds or titles.

The escrow holder will set up a timeline of the events that must occur for the transaction to be completed. This will include deadlines for each step, such as when payments are due and documents that need to be signed. When payments are due, the escrow holder will take money from the escrow account to pay any fees or taxes associated with the purchase.

They will also review your escrow account and see if there are any discrepancies between what was collected and what is owed. You may receive a refund or be billed for the difference if there is a surplus or shortage.

Once all the conditions are met, including any required inspections or loan payments, the escrow is released, and funds are sent to pay for what was agreed upon. This means that:

  • The seller will receive their payment for the sale of the house
  • The buyer will receive the deed and title to their new home
  • The lender will receive any funds necessary for loan payments and fees associated with the transaction

If any agreed-upon conditions are not met, the escrow will not be released until they are addressed and both parties agree on how to handle them. If the contract is terminated, so will the escrow. The funds will go back to the buyer, and the deed will be returned to the seller.

What Are the Different Types of Escrow Accounts?

There are various escrow accounts, including the following:

Independent Home Sellers or Buyers Escrows

This escrow is typically used between two parties in a private transaction. Before setting up an escrow account, both parties must agree upon the terms and conditions.

Mortgage Escrows

This escrow is most beneficial for buyers, providing a way for them to make monthly payments instead of a lump sum up-front. The mortgage lender will control the escrow account, collecting funds from the borrower each month to cover mortgage payments, property taxes, insurance premiums, and other related expenses.

Real Estate Sales Escrows

This escrow will typically be set up between a buyer and seller during a real estate transaction to ensure that all terms are met before the sale is completed. This escrow is favorable to real estate companies, ensuring that the buyer cannot use the funds from the sale for anything other than purchasing the property.

Construction Escrows

This escrow is used when a buyer and a contractor enter a deal to construct or remodel a property. Generally used by construction companies, this escrow will be held until a certain amount of work has been completed and the buyer is satisfied with the results.

Rent Escrows

Landlords typically use this escrow to ensure their tenants make timely rent payments. These funds can be used to pay insurance premiums and property taxes on behalf of the tenant and as a security deposit or dispute resolution.

What Are the Benefits and Drawbacks of an Escrow?

Before entering an escrow agreement, make sure you understand the benefits and potential drawbacks of using one.


Here are some of the advantages of using an escrow account:

  • Can protect buyers and sellers, as all conditions must be followed before funds are released
  • Makes tracking payments easier, ensuring that necessary funds are collected on time
  • Keeps all documents related to the sale in one place for easy tracking and access
  • Allows monthly payments to be made in place of a lump sum
  • Saves buyers from sellers who cannot transfer ownership of the property
  • Shields sellers against buyers who are unable to complete payment


Here are some of the potential drawbacks to using an escrow account:

  • Can be hard to terminate, as both parties must agree on how to settle any discrepancies
  • Can be costly to set up and maintain
  • May take a long time to be released
  • Requires higher monthly mortgage payments, as they must include funds to cover taxes and insurance
  • May cause an escrow shortage or surplus if estimates of taxes and insurance are off
  • Can be challenging to find a reliable third party 
  • No control over how the escrow is managed and when the funds are released

Before your next real estate transaction, consider whether an escrow account is the right option for you. Take into account the costs and potential risks associated with using one and any benefits it could provide.

How Can Escrow Protect You in Financial Transactions?

An escrow can protect both buyers and sellers from potentially fraudulent or risky transactions. It does this by verifying that all instructions are followed before funds are released and ensuring that both parties agree to the same terms.

When setting up an escrow account, it’s crucial to choose a reliable third party who will manage the account properly, as they will ensure the funds are available and released on time. They should also have a good reputation in the industry and be able to handle any disputes that may arise.

Fortunately, the Real Estate Settlement Procedures Act (RESPA) protects buyers and sellers from unethical practices by requiring escrow accounts to be managed in a certain way. This act sets out regulations for disclosing fees and other information related to escrow services and outlining responsibilities for maintaining an escrow account.

Overall, an escrow account is a great way to protect yourself in the event of a real estate transaction. It ensures that both buyers and sellers are held accountable, provides transparency throughout the process, and eliminates the possibility of fraud.

What Escrow Accounts Don’t Cover

Although escrow accounts are a great way to protect both parties in real estate transactions, it’s essential to know that they don’t cover everything.

Escrow accounts don’t cover any expenses related to homeownership, such as HOA fees and utility bills. They also don’t guarantee any warranties or repairs on the property or any protection against liens or other legal matters that may arise.

Should You Get a Mortgage Escrow Account?

Ultimately, getting a mortgage escrow account depends on your situation.

If you’re a buyer and don’t have the funds to cover taxes and insurance upfront, then a mortgage escrow could be a good option. On the other hand, if you’re a seller, then a mortgage escrow account can ensure that all funds have been collected before releasing the property to the buyer.

Whichever side of the transaction you’re on, an escrow account is a way to protect yourself and ensure that both parties understand the terms of the agreement and are held accountable.

Final Thoughts

As a homebuyer, mortgage escrow accounts are a great way to protect yourself and ensure that all aspects of your real estate transaction are handled correctly. However, it’s vital to consider any potential risks, costs, or benefits associated with using an escrow account before you make a decision.

Knowing the basics of escrow accounts and how they work will help you make the best choice for your next real estate transaction.

Are you interested in taking out a mortgage on a home? 

Reach out to an ASTAR Home Capital today! info@astarteam.com or 888-ASTAR-11 (888-278-2711) 

One of our All-Star Mortgage experts will be glad to assist you.

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