Escrow refers to a financial account in which the funds are managed by an intermediary like a law firm or dedicated escrow company on behalf of the two parties committed to a dealing or transaction.
The neutral third party won’t release the funds until the deal is complete.
The use of escrow accounts is quite common in real estate dealings, but it’s a valid means of keeping money on hold under a neutral party for any transaction.
During a home buying process, the first time you will need to use the escrow account is when making the earnest money deposit to reflect your intent of purchasing to the seller. You can get that money back if the appraisal returns the home’s value lower than the sales price or the home inspection finds serious issues with the home.
If you purchase a home on loan, your mortgage lender will ask you to put some money into an escrow account for paying the homeowners’ insurance premiums and property taxes. The provider uses money from this fund to pay tax bills and insurance premiums on behalf of the homeowner. It ensures that the bills are paid on time.
Every mortgage provider will do an escrow analysis each year because the rates of the insurance premium and property taxes are not fixed. This analysis ensures there are adequate funds in the account for paying these bills over the next year. The lender will send you a statement after each yearly review. There could be a shortage (not enough funds to cover the expenses) or overage (extra funds than necessary) in the account.
Setting up an escrow account is mandatory in any real estate transaction.