What is an escrow account?
An escrow account is a convenient way of managing your property taxes, insurance, and other expenses.
A mortgage payment is typically made up of four components: principal, interest, taxes and insurance.
The Principal portion is the amount that pays down your outstanding loan amount.
Interest is the cost of borrowing money. The amount of interest you pay is determined by your interest rate and your loan balance.
Taxes are the property assessments collected by your local government. Lenders typically collect a portion of these taxes in every mortgage payment and hold the funds in an account, called an escrow account, until they are due.
Insurance offers financial protection from risk. Like property taxes, homeowners insurance payments are typically held in an escrow account, and then paid on your behalf to the insurance company.
Two main types of insurance can be included as part of your mortgage payment.
Homeowners insurance is required financial protection you must maintain in case your property is damaged by fire, wind, theft, or other hazards. Depending on your geographic location, you may be required to get additional flood insurance.
Mortgage insurance protects your lender in case you fail to repay your mortgage. Whether or not mortgage insurance is required usually depends on the size of your down payment and other circumstances.
In the early stages of your mortgage term, only a small portion of your monthly payment will go toward repaying your original principal.
As you continue to make payments through the years, a greater portion will go to reducing the principal.
When you understand the components of your mortgage, how they change over time, and how they can affect equity, you are in a better position to manage it.