Our top picks of timely offers from our partners

More details
UFB Secure Savings
Learn More
Terms Apply
Up to 5.25% APY on one of our top picks for best savings accounts plus, no monthly fee
National Debt Relief
Learn More
Terms Apply
National Debt Relief helps consumers with over $10,000 of unsecured debt and has operated since 2009
LendingClub High-Yield Savings
Learn More
Terms Apply
Our top pick for best savings accounts for its strong APY and an ATM card with no ATM fees
Choice Home Warranty
Learn More
Terms Apply
Protects 25+ systems & appliances. Free quote + $50 off + 1 month free
Freedom Debt Relief
Learn More
Terms Apply
Freedom Debt Relief can help clients get started without fees up front
Select independently determines what we cover and recommend. We earn a commission from affiliate partners on many offers and links. This commission may impact how and where certain products appear on this site (including, for example, the order in which they appear). Read more about Select on CNBC and on NBC News, and click here to read our full advertiser disclosure.
Mortgages

What is an escrow account and how does it work?

An escrow account protects both the buyer and the seller in the homebuying process.

Share

Buying a house is the largest financial transaction most of us will ever make. So it's fairly common for a trusted third party to hold onto the money while the deal is completed or other conditions are met, protecting both the buyer and seller from nonpayment or fraud.

You may have heard of this legal arrangement as being "in escrow."

While an escrow account can be used in other situations — online sales, legal settlements and the stock market, for example — it's most commonly associated with home buying and ownership.

CNBC Select looks at what real estate escrow is, how it's calculated and the advantages and drawbacks of .

What we'll cover

What is an escrow account?

The funds in an escrow account are held by a third party until the transaction is complete. In the world of real estate, there are two main types of escrow.

Homebuyers escrow

Buyers are often asked to put a deposit down to show their interest is legitimate, especially if the down payment is less than 20% of the total purchase price. To protect both them and the seller, that deposit is put into an escrow account until the sale is completed. If the seller stops the sale, the funds in escrow are returned to the buyer. If the deal is interrupted because of the buyer, though, the seller typically keeps the money.

When the purchase is completed, the funds in the escrow account are typically applied toward the down payment.

Mortgage escrow

After you've purchased a home, your lender will likely require an escrow account for you to deposit your monthly mortgage, insurance and property tax payments, especially if your down payment was less than 20%.

A Chase Bank mortgage is a great option for borrowers looking for a smaller down payment. Chase's DreaMaker home loan allows buyers to put down as little as 3% of the home's price.

Chase Bank

  • Annual Percentage Rate (APR)

    Apply online for personalized rates; fixed-rate and adjustable-rate mortgages included

  • Types of loans

    Conventional loans, FHA loans, VA loans, DreaMaker℠ loans and Jumbo loans

  • Terms

    10 – 30 years

  • Credit needed

    620

  • Minimum down payment

    3% if moving forward with a DreaMaker℠ loan

  • Terms apply.

  • Offers first-time homebuyer assistance?

    Yes — click here for details

CNBC Select also recommends Ally Bank Mortgage: In addition to a low down payment, Ally waives origination fees and offers fixed-rate and adjustable-rate mortgages, as well as 15-year, 20-year and 30-year loan terms.

Ally Home

  • Annual Percentage Rate (APR)

    Apply online for personalized rates; fixed-rate and adjustable-rate mortgages included

  • Types of loans

    Conventional loans, HomeReady loan and Jumbo loans

  • Terms

    15 – 30 years

  • Credit needed

    620

  • Minimum down payment

    3% if moving forward with a HomeReady loan

Terms apply.

How is escrow calculated?

Escrow for homebuyers is typically 1% to 3% of the total cost of the property. Mortgage escrow is usually determined by the lender, who estimates your property taxes, insurance payments and other expenses for the next year and divides the total by 12.

This amount is typically added to your mortgage, so you just have one simple payment to track.

Who manages escrow services?

When a seller accepts a bid, the buyer's good-faith deposit is put into an account that may managed be by an escrow agent, title company or mortgage servicing company. Typically, that company is paid a fee.

For homeowners, mortgage escrow accounts are typically managed by the lender, who has a vested interest in making sure they pay their bills on time.

Pros of an escrow account

Using an escrow account can provide peace of mind to all parties involved in a home sale.

For homebuyers: Escrow protects your deposit by putting it in the hands of a third party for safekeeping. If it was with the seller, there could be problems getting it back if the sale fell through.

For homeowners: You don't have to keep track of monthly property tax and insurance payments as they're automatically paid on time. In addition, you can avoid facing an enormous tax bill you've been contributing incrementally.

For lenders: Using an escrow account to cover mortgage, insurance and tax payments can help prevent foreclosure and ensure insurance is available in the event of an accident or natural disaster.

Cons of escrow

While escrow does provide a lot of benefits, there are some downsides.

Loss of investment opportunities: In addition to your mortgage, you're also paying a chunk of your property tax bill and insurance premiums into the account — money that can't be earning a higher return elsewhere.

High upfront costs: Many escrow accounts require a minimum balance to cover unexpected expenses. You may have to keep an extra two or three months' worth of property taxes and insurance premiums as a cushion, or "escrow reserve."

It's only an estimate: Your monthly payments are typically based on last year's bills, but that's only an estimate. If your property taxes went down, you've actually been tying up more money than you needed to.

FAQs

If your down payment is at least 20%, it's not mandatory to have an escrow account with most home loans. You'll need to ask your lender for an escrow waiver to allow you to pay property taxes, insurance premiums and other expenses directly, however, and there may be a fee involved.

Since escrow covers property taxes and insurance premiums, you'll typically pay into the account for the entire length of the mortgage.

Typically, buyers have to put between 1% to 3% of the purchase price of their home in an escrow account. This is referred to as "earnest money," essentially proof they intend to complete the deal.

Once you submit payment into your escrow account that money is no longer available for other uses.

Typically, no. Lenders in only 15 states are required to pay interest on escrow accounts.

Subscribe to the CNBC Select Newsletter!

Money matters — so make the most of it. Get expert tips, strategies, news and everything else you need to maximize your money, right to your inbox. Sign up here.

Bottom line

While escrow accounts can be used in different fields, in the homebuying process it is used to protect the buyer's deposit until the deal is complete. At that point, it's usually put toward the down payment.

An escrow account can also be used to ensure that mortgage, insurance and tax payments are made promptly.

Why trust CNBC Select?

At CNBC Select, our mission is to provide our readers with high-quality service journalism and comprehensive consumer advice so they can make informed decisions with their money. Every article is based on rigorous reporting by our team of expert writers and editors with extensive knowledge of financial products. While CNBC Select earns a commission from affiliate partners on many offers and links, we create all our content without input from our commercial team or any outside third parties, and we pride ourselves on our journalistic standards and ethics.

Catch up on CNBC Select's in-depth coverage of credit cardsbanking and money, and follow us on TikTokFacebookInstagram and Twitter to stay up to date.

Editorial Note: Opinions, analyses, reviews or recommendations expressed in this article are those of the Select editorial staff’s alone, and have not been reviewed, approved or otherwise endorsed by any third party.
Chime
Learn More
Terms Apply
Chime offers online-only accounts that minimize fees plus, get paid up to 2 days early with direct deposits
Find the right savings account for you
Learn More
Terms Apply
Help your money grow by finding the savings account that offers the best rates and features for you