Explaining Escrow: What VA Homebuyers Need to Know

First-time VA homebuyers run into a lot of new words and phrases as they begin the purchase process. One of the most unfamiliar is "escrow," a concept that many people don't encounter outside the mortgage industry. But it's an important part of the closing process that veterans should understand from the outset.

So what is escrow? Escrow is basically depositing money with one entity who will deliver it to another upon the completion of a transaction or a set of conditions. It's a way to safeguard your investment while showing you're able to deliver on a financial promise.

Escrow most commonly plays a role in the home purchasing process in regards to homeowners insurance and property taxes.

Escrow Insurances and Taxes

No matter where you purchase, homeowners insurance and property taxes are likely to be part of your future. Obtaining insurance for your new property isn't just a smart financial move -- lenders are going to require it. After all, the bank technically owns the home until you pay the loan off, and they want to make sure their investment is protected.

Many homeowners will also pay local property taxes. Some communities and states provide discounts or total exemptions for disabled veterans.

Both homeowners insurance and property taxes are annual costs that can vary year to year. There are two different ways to pay them. One is to simply get one tax bill or one homeowners insurance bill each year and pay the cost in full. The average annual homeowners insurance premium was about $800 in 2008, the last year for which data is available, according to the U.S. Census Bureau.

The same year the average property tax bill nationwide was about $1,200. That's a combined $2,000 homeowners would be responsible for one in yearly hit.

More commonly, homeowners will escrow funds with their lender for their homeowners insurance premium and property taxes. Rather than pay the $800 insurance bill all at once, they'll split it up over 12 months (about $67 per month). Escrow for the property taxes comes out to $100 per month.

You'll see the acronym PITI used to describe your monthly mortgage payment. That stands for Principal, Interest, Taxes and Insurance, as those are the four components of most homeowners' payment. The more bite-sized approach is much easier for many buyers. It's also something that many lenders are going to require.

Is Escrow Mandatory?

The answer to this question is the same you'll get when inquiring about a lot of other VA loan requirements: No, the government doesn't require you escrow funds, but your mortgage lender likely will. Much of the reason why is security on the lender's part -- having you deposit funds in escrow ensures you're actually paying your homeowners insurance and property taxes. Failing to do either can have significant impacts on the viability of the property.

As part of your closing costs a lender may require you to deposit money into an escrow account for both homeowners insurance and taxes. There are limits to what a lender can require you to escrow. A common request is three months' worth of tax payments and 15 months of homeowners insurance payments.

Like pretty much anything else in the homebuying transaction, these up-front escrow costs are something you can ask the home seller to cover. On a VA loan the seller is able to pay up to 4 percent of the loan amount in concessions for prepaid costs like this.

Questions about escrow or any other part of the buying process? Talk with a Veterans United loan specialist anytime at 855-870-8845.