Oh, do you mean “Escrow”? Or do you mean “Escrow”?
Same word different function
After all the articles I have written, I think it is about time I write a short piece regarding the meaning and function of “escrow”. This is not only a term that is used in the Lending industry but also in the Settlement Services industry. And in each, it denotes a different function. This makes it quite confusing for the general public and is used incorrectly in different context. Here is a simple summarization of both.
In both the word “escrow” denotes an account set up in trust with instructions for the handling of specific funds or documents.
Lending industry and their “Escrow “ account
Certain types of loans require that an “escrow” account be set up. Loan amounts that are given for more than 80% of the value of the property means that the Borrower has less out-of-pocket contribution. In order to maintain assurance that certain obligations to ownership are met, a requirement for approving such a loan would be to set up an escrow account. This account is also known as an “impound” account and handles the deposit from the Borrower of funds that are then used by the Lender for the payment of Borrower’s taxes, insurance and mortgage insurance.
Without payment of taxes the County Tax Collectors may, after a certain period of time of non payment, place the property on Notice of Sale to recuperate the delinquent taxes. This jeopardizes the mortgage, so the Lender, to stop a Tax Sale of the property, will advance the payment of unpaid taxes.
Without payment of insurance the Lender’s security interest in the property may also be jeopardized, particularly in the event of fire or other property destruction. In the event the Borrowers did not keep their fire insurance coverage current, the Lender, to assure themselves that continuous fire insurance is kept, will advance payment to insure their own security interest in the dwelling.
Then there is the issue of mortgage insurance coverage. There are two types – private mortgage insurance policy for a conventional loan or an FHA required mortgage insurance premium. Mortgage insurance is required by the Lender when their loan is more than 80% of the value. Purchasing this type of insurance provides the Lender some compensation in the event the Borrower’s default on the loan .
The premium of all three items above are calculated and paid on a monthly basis, with an advance payment of an extra few months at the start of the loan. These payments are included with the monthly mortgage principal and interest payment and then separated and deposited into an escrow/ impound account. When the due dates for the items arrive, the Lender will take the money out of the impound account and pay. If the amount of the taxes and/or premiums increase, the Lender will demand additional funds from the Borrower to make up the difference. Remember that this escrow impound account is set up with specific conditions and documentation agreed to and signed by the Borrower together with the other loan documents.
Under certain conditions the Lender may cease the collection of these funds. Borrowers should inquire with their lenders as to what conditions have to be met and how to proceed with the request to remove the impound account requirement.
When the loan is paid in full any funds remaining in the impound account are returned to the Borrower.
Settlement Services industry and their definition of “Escrow”
In the settlement services industry, this word describes the settlement process. “Going into Escrow” is the process of depositing money and documents with an impartial neutral third party who will hold them until all the mutually agreed upon conditions between the parties have been met. This is a process for the refinance or sale of real property and also business opportunities. The company can be called an “Escrow” company in parts of California and some of the western states, or it can be a Title Company in other parts of country, or an Attorney who specializes in handling such transactions in other areas.
There are many names that we give this “third party” – Escrow Holder, Settlement Agent, Stakeholder. No matter which different type of entity handles it, the basic function is the same – that of a neutral third party holding the funds in trust.
To add to the confusion of this term “escrow”, a Borrower can open an escrow transaction for the refinancing or placement of a new loan. In such a scenario the 2 parties – Lender and Borrower – will employ this third party to fulfill all necessary conditions to make sure the title ownership of the property is clear. The Lender will then fund the loan to the escrow who will then remit them to the Borrower.
For further information of the role that an Escrow Holder plays can be found in another article here .
Two distinctly different functions and meaning to the word, yet with a common denominator: the setting up of an account in which funds are held in trust and the parties have a pre-agreed upon set of conditions for the use of the funds. When a person is talking or asking about an “escrow” account it behooves the other party to clarify: Are we talking about an escrow “impound” account set up to handle payments made to a Lender through the course of a loan? Or is it an escrow “transaction” account set up to handle the transfer of real estate and/or business?
I hope this provides some clarification to the word and the way its role and meaning differs.
If you have any other questions, be sure to send us the question by email or in our Viva Community forum. Your questions deserve to be answered!
Juliana Tu, CSEO, CEO, CBSS, CEI, SASIP
Good news! “The Art of Escrow” is out! Look for it on www.amazon.com!
The Art of Escrow:
The Fight For Your American Dream and the Pursuit of Homeownership
Available now at Amazon.com
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