What the Heck Is an Escrow Account, and How Does It Even Work?

What the heck is an escrow account, and how does it even work?

My name is Evan Kaufman, your VA loan educator, here to help explain.

The term “escrow account” can actually mean one of two different things, and today we’re going to cover both. I like to think of them as pre-closing escrow and post-closing escrow.

The word “escrow” is commonly used interchangeably, which can sometimes be confusing. So let’s break it down and make it clear.

Pre-Closing Escrow

First, let’s talk about pre-closing escrow.

When people refer to escrow before closing, they’re generally talking about the title company or closing agent preparing everything needed to complete the transaction.

For example, let’s say you get a home under contract or you’re refinancing your current home. You may hear someone say, “We need to open escrow.” In some states, such as California, that’s a very common expression.

What they mean is that the title company is beginning the closing process and getting everything ready. You might also hear someone say, “We need to put funds into escrow.”

During this stage, an escrow officer, title officer, closing team, or even an attorney—depending on the state—is responsible for collecting all of the funds and documents needed for closing. Once everything is complete, they distribute the money to the appropriate parties.

Let’s use a home purchase as an example.

In a purchase transaction, the escrow officer or title company acts as a trusted third party. The buyer sends their funds to escrow, the lender sends the loan proceeds, and the seller provides any required documents related to the sale.

Once all of the conditions have been met, the escrow officer distributes the funds, records the transaction, and the home officially closes.

So, when you hear terms like opening escrow, working with an escrow officer, or funds in escrow, they’re referring to this pre-closing process.

Post-Closing Escrow

Now let’s talk about the second meaning of escrow: post-closing escrow.

This is the type of escrow account you’ll usually see listed on your mortgage documents.

Unlike the title company’s escrow account, this escrow account exists after closing and is used primarily to pay your property taxes and homeowners insurance. While it can sometimes be used for other expenses, taxes and insurance are by far the most common.

When you close on your home, you’ll typically have an escrow account established as part of your mortgage. This is the account that collects money over time to make those future payments on your behalf.

In my experience, I’d estimate that around 95% of mortgages have an escrow account after closing.

Instead of paying your mortgage lender for principal and interest, paying your county separately for property taxes, and paying your insurance company separately for homeowners insurance, you make one monthly mortgage payment.

That payment includes:

• Principal

• Interest

• Property taxes

• Homeowners insurance

The principal and interest go toward your loan, while the taxes and insurance are deposited into your escrow account.

Since property taxes and homeowners insurance generally aren’t paid monthly—they’re often due annually or semi-annually—the escrow account gradually builds up the necessary funds. Then, when those bills come due, your loan servicer pays them on your behalf.

The Difference

So, to summarize:

Pre-closing escrow is the process of collecting and distributing funds during the real estate transaction. It’s handled by the title company, escrow company, or closing attorney.

Post-closing escrow is an account tied to your mortgage that collects money each month to pay your property taxes and homeowners insurance throughout the life of your loan.

Both are called “escrow,” but they’re two completely different things.

I hope this helped demystify the two major ways you’ll hear the term escrow used.

My name is Evan Kaufman, your VA loan educator.

Take care.