What is escrow on a mortgage and why is it part of the monthly payment?
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Escrow just means someone else is holding money for you.
In this case, it’s likely money for property tax and/or insurance. The bank has lent you money to buy a home, and if you fail to repay the money they will take the home away from you. Most people understand that.
But property taxes also need to be paid, and if you fail to pay your property tax the government will come and take the property away. This is a concern for the bank, because if the government takes the property away the bank will be unable to take the property. And it’s highly unlikely that you are going to keep paying a mortgage payment on a property that the government has taken away.
So to solve this problem the bank wants to make 100% sure that the property taxes are being paid. There’s lots of ways that they could do it, but the easiest is just to collect the property tax money from you, and send it to the government. That way if you fail to pay, they know right away, well before the government will come take the property.
That’s normally the monthly escrow payment included in your mortgage. It’s the bank collecting the property tax in advance, then paying it to the government so that they won’t get the home taken out from under them.
They sometimes do the same thing with insurance, for the same reasons. If you fail to insure the house, then it burns down, you’re not going to want to pay the mortgage anymore but the property is worth a lot less so the bank can’t take it away from you to sell it to recover the loan. So they do the same deal that they do with property taxes, they charge you in advance, then pay the insurance for you that way they know it’s been properly taken care of.
Often you can arrange to do these things yourself, but it’ll make the bank a little uncomfortable for obvious reasons (they don’t entirely trust that you’re going to actually DO it). And if you fail to pay the taxes or insurance, you’ll screw both yourself and the bank. The bank does not really care if you screw yourself but they care a lot if you screw the bank.
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