What Is an Escrow Account? How Property Tax and Insurance Get Paid

If your mortgage payment includes more than principal and interest, the extra money is probably going into an escrow account. It is one of the main reasons your total payment can change even when your interest rate is fixed.

What escrow is

An escrow account, sometimes called an impound account, is a holding account managed by your loan servicer. Each month, along with principal and interest, you pay one-twelfth of your estimated annual property tax and homeowners insurance (and flood insurance or mortgage insurance, if they apply). When those bills come due, the servicer pays them for you.

For example, if your annual property tax is $5,400 and your insurance is $1,800, the escrow portion of your payment is ($5,400 + $1,800) ÷ 12 = $600 a month.

Lenders like escrow because it ensures taxes and insurance get paid, which protects their security in the home. It also spares you from saving for large bills yourself.

Why your payment changes

Your principal and interest stay the same on a fixed-rate loan, but your escrow portion does not. Once a year your servicer performs an escrow analysis, comparing what it collected with what it paid and projecting the next year. If property taxes or insurance premiums rose, your monthly escrow goes up. If you were over-collected, you may receive a refund.

An escrow shortage happens when the account is short because costs rose during the year. The servicer may ask you to pay it in a lump sum or spread it over the next twelve months, which raises the payment.

The cushion

Federal rules allow a servicer to keep a cushion in the account, up to two months of escrow payments, to cover increases. That is why your first payments or your closing costs may include an initial deposit to escrow larger than a month or two of bills.

Do you have to have one?

It depends on the loan. Many lenders require escrow when you put down less than 20%, and FHA, VA and USDA loans generally require it. If you have a conventional loan with enough equity, you may be allowed to pay taxes and insurance yourself, sometimes for a fee or a slightly higher rate. Paying yourself gives you control of the cash but requires discipline to set money aside for the due dates.

Estimating escrow before you buy

Use the actual tax bill and a real insurance quote when you can. Property tax in particular can differ from the seller’s bill, because many areas reassess a property after it sells. The property tax by state page shows typical rates, and the mortgage calculator includes tax and insurance in the full monthly payment when you enter a ZIP code.

Tips

1. Review your annual escrow statement and check the tax and insurance amounts.
2. Shop your homeowners insurance each year, since the premium feeds directly into your payment.
3. If you think your property is over-assessed, you can appeal with the local assessor.
4. Keep some savings for a shortage so an increase does not catch you off guard.

Common questions

Why did my escrow payment go up?

Usually because your property tax bill or homeowners insurance premium increased. Servicers review the account each year and adjust the monthly amount so the account can cover the bills. Reassessment after a purchase, a new tax rate or an insurance renewal at a higher price are the usual causes.

Can I get my escrow money back?

If the account holds more than the allowed cushion after the annual analysis, the servicer must refund the surplus above a small threshold. When you pay off the loan or sell, the remaining balance is returned to you.

Is escrow worth it even if it is optional?

For many people, yes. It spreads large annual bills into monthly pieces and prevents missed payments. If you are disciplined and prefer to keep control of the cash, paying the bills yourself can work, but you must set aside the money so a large bill does not catch you short.

Key takeaways

• Escrow collects one-twelfth of your tax and insurance bills each month.
• Your principal and interest can stay fixed while your total payment changes.
• Review the annual escrow statement and shop insurance every year.