To understand what an escrow payment is, it is necessary to first understand two terms. Escrow is the first term, which describes a situation where something is kept by a neutral third party. Next, mortgage is money that is loaned to a borrower who uses it to buy real estate. An escrow payment, therefore, is money that a mortgage lender receives from a borrower and places into an account for the payment of taxes and insurance.
When a person borrows money to purchase real estate, it is usually repaid to the lender or current mortgage holder in monthly installments. Such a payment would normally include a portion of the principal, which is the actual amount borrowed, and a portion of the interest on the loan. When there is an escrow payment to make, an additional amount is added and collected monthly.
This additional money is generally used to pay the borrower’s property taxes and homeowner’s insurance. Property taxes are charges collected by the locality where the real estate is located; it is based on the property’s value. Homeowner’s insurance is a service that offers coverage in the event certain damages occur to the property.
These items are not usually due on a monthly basis. This means the mortgage lender must guard the money until the time of payment. To do this, the mortgage lender places the money into an escrow account, which is usually in the possession of a third party. Here, it can earn interest, which will increase the amount the borrower has available to make payments.
In some instances, an escrow payment system is an option. Even if a person did not choose it in the beginning, she may be able to open an escrow account during the span of her mortgage repayment. In other cases, it is a requirement and the borrower will be bound to the arrangement until the mortgage is fully repaid. One instance in which an escrow payment system is likely to be mandatory is when a borrower makes a down payment of less than 20 percent.
Fannie Mae says there are several benefits to the escrow payment system. The ability to manage a household budget in a less stressful way is one of them. Since the payments are made in small portions, there is no pressure to pay a single lump sum on the due date. Another benefit, says Fannie Mae, is that homeowners do not have to keep track of these bills or their due dates. They can rest assured that whatever the cost, it will be paid in a timely manner.