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What You Should Know About Using An Escrow Account For Your FHA Loan

May 26, 2022

FHA mortgage loans

Are you planning to buy a home? Whether you seek an FHA mortgage or not, you may be required to use an escrow account for the loan transaction. You will need a safe place to deposit earnest money in the buying phase and you may also need escrow to pay your property taxes each year.

FHA Loans Require Escrow

Your participating FHA lender may require the use of an escrow account. Are you applying for an FHA 203(k) Rehabilitation Loan or an FHA One-Time Close Construction loan?

Both types of mortgages require payments to contractors who are renovating or constructing your home. FHA loan funds must be stored in escrow until it’s time to use them. There is no unrestricted cash back to the borrower with these loans, so escrow is necessary.

You may find an escrow requirement also applies for FHA Reverse Mortgages, and for these loans, escrow is used to manage property taxes. FHA forward mortgages may also require you to pay your property taxes via escrow.

Why Escrow?

The first reason escrow may be required is protection. When earnest money in left in an escrow account, it is protected.

For example, if you need to exercise your right under FHA loan rules to cancel a transaction where the asking price of the property is higher than the appraised value? When your money is in escrow you won’t have to worry about the seller doing the right thing and returning the cash–it will be transferred back to you by the lender from escrow.

And then there are property taxes due after you own the home. You may be required to deposit your property tax payments in escrow, and those funds will be kept there until they are used to pay the taxes.

Automatic payment of those taxes helps you avoid missed deadlines, and threats of legal action associated with a lack of payment on those taxes.

Things To Remember About Escrow

Your money might sit in your escrow account longer than you expect it to; in many cases, this is not due to an oversight by the lender but motivated by a specific circumstance. One such issue is known as an escrow holdback.

That could apply in cases where you and the seller agree on a later move-in date than a closing day, or if there was a problem with the property during the final walkthrough and more information is needed.

And let’s not forget about situations like the need to pay contractors for renovation or construction work as part of the loan. In these cases, escrowed money could remain in the account until you have officially approved the work.

When it comes to paying your property taxes using escrow, those taxes are subject to change each year depending on the housing market, any applicable changes to the value of your home, and other variables. 

You’ll need to anticipate an increase in property taxes or work out an arrangement with the lender for dealing with any extra funds needed.

You and your lender may agree to have you make a one-time payment covering the tax shortage, or you may have to negotiate a different way to cover the extra amount such as an increased mortgage payment.

Bruce Reichstein - FHA News Author

By Bruce Reichstein

Bruce Reichstein has spent over three decades as an experienced FHA and VA home loan mortgage banker and underwriter where he was responsible for funding “Billions” in government backed mortgage loans. He is the Managing Editor for FHANewsblog.com where he educates homeowners on the specific guidelines for obtaining FHA guaranteed home loans.

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