What is Escrow Accounting?
Escrow accounting records and reports financial transactions related to two separate parties. Escrows are commonly found in the banking and financial services industry. Individuals obtaining loans from banks, lenders, and financial institutions usually place money in escrow. These funds are released after specific loan conditions are met. Accounting procedures separate escrow funds from other money in an accounting ledger. Neither party has unfettered access to the money for purposes outside of the escrow guidelines.
General and interest-bearing escrow accounts are the most common in the business environment. Mortgage companies primarily use general escrow accounts. Buyers place money in this account relating to the purchase of a home. The title or mortgage company requires buyers to place money in escrow for future payments relating to mortgage interest, homeowners insurance, and property taxes. Interest-bearing accounts allow managers to accrue interest on escrow money for use by the parties involved in the financial transaction. General escrow accounts to not have this feature.
The escrow accounting equation is assets equal liabilities. No owner’s equity or retained earnings is found in escrow accounting. Escrow accountants have a fiduciary responsibility to process funds from both parties in a financial transaction. Accountants must safeguard the money from loss that can relate to either party’s failure to complete their duties in the financial transaction. Financial transactions represent individual entries into the general ledger. The general ledger contains information relating to all escrow financial transactions.
Similar to regular accounting procedures, general ledgers in escrow accounting may use sub-ledgers or journals to record financial transactions. The cash disbursements and cash receipts journals are the most common found in escrow accounting. The cash disbursements journal includes financial transactions relating to the payment of escrow funds. Paying out escrow funds occurs when one or both parties complete their duties relating to the escrow account. The cash receipts journal records all money is coming in for an escrow purposes. The cash receipts journal can include detailed information relating to each party in the escrow transaction, each party’s financial responsibility and other pertinent information.
Reconciliations are an important part of escrow accounting. Accountants will review information relating to individual escrow accounts on a weekly or monthly basis. Each escrow account is tested to ensure that the cash inflows and outflows properly account for escrow monies. Escrow account differences may need corrections to ensure each party is in full compliance with its escrow responsibilities. Escrow accounts commonly issue written statements to each party indicating the current state of the escrow account.
I can see the advantages of having money in an escrow account for mortgage purposes. Not only do you not have to worry about making the payments, but it also gives the mortgage company some extra security knowing these will be paid.
Having said that, I choose not to have a general escrow account for my property taxes. I set aside the money I know I will need and pay the taxes myself.
We pay our property taxes twice a year and I have it down on my event calendar when they are due. Sometimes I do have a fear of forgetting to pay, but do have a back up.
The loan officer at the bank where we have our mortgage says that she keeps track, and would give me a call if she noticed the taxes were not paid.
If a professional was giving accounting advice, I don't know if they would recommend keeping your money in escrow or not, but I think it comes down to personal preference.
Just as an accountant who keeps track of the escrow money and has checks and balances, I am doing the same thing when I keep track of it myself. It's just that I only have to keep track of one account, where the escrow companies have thousands to keep track of.
We have money in a general escrow account to pay our homeowners insurance and property taxes. What I like about this is that I don't have to remember to pay my taxes or insurance.
Another advantage to having money in escrow is that you don't have to come up with a big lump sum to make these payments.
When property taxes are due, this can be a big payment if you aren't prepared for it. If you have your money in escrow, this is paid for you from the money you already have in the escrow account.
I do remember when our property taxes increased, and our escrow account didn't have enough money so our payment amount increased so this would be covered.
This amount was figured by the escrow accounting department, and we were notified by them in writing.
Even though this was frustrating, it was better than coming up with the whole payment at once.
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