Escrow account, also known as an impound account, is an account set up by the lender to hold the homeowners’ property taxes and insurance to be paid when due. Lenders prefer this method because it acts as extra insurance in knowing that the homeowner will not default on property taxes and insurance coverages will always be in place. Funds are set aside in advance through the impound account, essentially a savings account for when the bill is due. Homeowners sometimes prefer escrows/impounds because it allows them to pay all their associated costs in a monthly bill, rather than a lump sum.
In residential real estate there is only one type of escrow account – escrow accounts may be used in other fields or transactions for legal/trust reasons but there are variations on the items that an escrow contains. For example, an escrow usually includes property taxes, homeowner’s insurance, and mortgage insurance, but a lender may not require all 3 of these items.
You do not always need an escrow account with your mortgage, but there are some cases such as low-down payment loans where the lender requires it as part of the condition of the financing. This is almost always the case when it comes to FHA loan and VA loans. It may also be required with a conventional 3% and sometimes 5% down loans. Outside of that it is totally voluntary. The escrow account itself is managed by the servicing lender.
Convenience for the customer and the servicing lender has a sense of security about the mortgage.
Downsides include loss of control and use of your money- the impound account does not pay interest and accounting errors also commonly occur within the impound escrow process. Getting these issues resolved can be frustrating and time consuming. A good alternative is to simply draft the monthly impound amount (taxes and insurance) into a separate savings account, that you control and pays you some interest.