An escrow account is essentially a savings account set up by your lender to pay for future expenses. The two most common expenses escrowed are property taxes and home insurance, although there may be other expenses your lender may want to escrow.
Many home buyers would prefer to keep the money for taxes and insurance in their own bank accounts, so that they can collect the interest. Other buyers look at escrow accounts as a form of forced savings, and rest easier knowing the the money will be there when the bills are due.
However, you may not have a choice as to whether or not your tax and insurance payments will be put in an escrow account. Many lenders will require you to maintain an escrow account as a condition of your mortgage. Moreover, Federal Housing Administration (FHA) loans and Veterans Administration loans require escrow accounts.
The payments into your escrow account will be added to your monthly mortgage payments. The Real Estate Settlement Procedures Act (RESPA) places limits on how much money a lender can require you to pay into your escrow account.
If, at the end of the year, you've paid in more than was required for taxes, insurance, and so on, any amount left over in excess of $50 must be refunded to you.
However, the lender is allowed to have you pay additional money into your escrow account in order to make sure that there's sufficient funds in the account when the various bills are due. Under RESPA, these additional payments cannot exceed 1/6th of the total amount the lender pays out of the account.
The Department of Housing and Urban Development (HUD) has a Frequently Asked Questions page about escrow accounts at http://www.hud.gov/offices/hsg/sfh/res/respafaq.cfm .
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