Real Estate Finance
What Is an Escrow Account in Real Estate?
In real estate, 'escrow' describes two related concepts: a transaction escrow (a neutral third party holds funds during closing) and a mortgage escrow account (a lender-managed account collecting monthly tax and insurance payments). Both appear frequently on the real estate licensing exam.
Two Types of Escrow
Transaction Escrow
During a real estate sale, earnest money and closing funds are held by a neutral third party (title company, escrow company, or attorney) until all contract conditions are met. When the transaction closes, funds are disbursed to all parties. This protects both buyer and seller.
Mortgage Escrow Account
Many lenders require borrowers to maintain an escrow account for property taxes and homeowner's insurance. Each month, 1/12 of the annual tax and insurance bills is collected as part of the mortgage payment (the T and I in PITI). The lender pays the bills when due.
Escrow Shortages and Surpluses
Lenders perform an annual escrow analysis. If the account has too little to cover upcoming obligations, the borrower faces a shortage (paid as a lump sum or spread over 12 months). If there is a surplus greater than one month's payment, the lender refunds it.
Real Estate Exam Key Points
Transaction escrow is held by a neutral third party — not the buyer or seller
Mortgage escrow pays property taxes and homeowner's insurance
Lenders may require escrow when LTV exceeds 80%
Escrow is NOT a savings account — reserved specifically for tax and insurance
Annual escrow analysis determines if shortage or surplus exists
Brokers must hold client earnest money in a separate trust/escrow account — never co-mingled with operating funds
Definition Page Pillars
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