When you make a mortgage payment each month, you may be paying more than just principal and interest. Many homeowners also have an escrow account that helps cover expenses such as property taxes and homeowners insurance.
An escrow account can make managing these large annual or semiannual bills easier because the costs are divided into smaller monthly payments and collected along with the mortgage payment.
Understanding how mortgage escrow works can help you better understand where your monthly payment goes and why that amount may change over time.
What Is a Mortgage Escrow Account?
A mortgage escrow account is an account used by a mortgage servicer to collect and hold money for certain property-related expenses.
Instead of paying a large property tax or homeowners insurance bill yourself when it comes due, you may contribute toward those expenses every month as part of your mortgage payment.
The mortgage servicer then uses the money in the escrow account to pay the applicable bills when they become due.
Common expenses paid through escrow include:
- Property taxes
- Homeowners insurance
- Flood insurance when required
- Other approved property-related expenses
The exact expenses included can vary depending on the mortgage and lender requirements.
How Does Mortgage Escrow Work?
The basic process is relatively straightforward.
When your mortgage payment is calculated, the lender or servicer estimates how much you will need for eligible property expenses throughout the year.
That estimated amount is divided into monthly payments.
For example, suppose your estimated annual property taxes are $6,000 and your homeowners insurance costs $1,200 per year.
Your estimated annual escrow expenses would be:
- Property taxes: $6,000
- Homeowners insurance: $1,200
- Total: $7,200
Dividing $7,200 by 12 months gives an estimated escrow contribution of $600 per month.
Your total mortgage payment would then generally include your principal and interest plus the amount being collected for escrow, along with any applicable mortgage insurance or other charges.
What Does Escrow Pay For?
The two most common expenses paid through mortgage escrow are property taxes and homeowners insurance.
Property Taxes
Property taxes are typically paid to your local government.
Because property taxes can represent a significant annual expense, spreading the cost across monthly mortgage payments can make budgeting easier.
The mortgage servicer collects the money throughout the year and uses the escrow account to pay the tax bill when it is due.
Homeowners Insurance
Homeowners insurance protects your property against covered risks and is commonly required by mortgage lenders.
If your insurance premium is included in escrow, a portion of the annual premium is collected each month.
The servicer then uses the escrow funds to pay the insurance premium when it becomes due.
Other Insurance
Depending on the property and mortgage requirements, escrow may also be used for other insurance expenses.
For example, certain properties may require flood insurance or other specialized coverage.
Your mortgage documents and servicer can explain exactly what is included in your escrow account.
Why Do Mortgage Lenders Use Escrow Accounts?
Escrow helps ensure that important property-related expenses are paid on time.
From the lender’s perspective, property taxes and insurance are important because unpaid taxes can create liens against a property, while insufficient insurance coverage can create additional risk for the property securing the mortgage.
For homeowners, escrow can also provide a more predictable way to manage these expenses.
Instead of having to save for a large annual bill separately, you contribute toward it throughout the year.
Is Escrow Included in Every Mortgage Payment?
Not necessarily.
Whether an escrow account is required or available depends on factors such as:
- Loan type
- Down payment
- Property type
- Lender requirements
- State or local requirements
- The borrower’s financial circumstances
Some borrowers may have an escrow account while others may be responsible for paying property taxes and insurance directly.
Your mortgage professional can explain whether escrow will be part of your particular loan.
Why Can Your Mortgage Payment Change If You Have Escrow?
One common misconception is that your mortgage payment will always remain exactly the same.
Even if your principal and interest payment remains unchanged on a fixed-rate mortgage, the escrow portion can change.
This can happen when property taxes or insurance premiums change.
For example, if your homeowners insurance premium increases, your servicer may need to collect more money each month to cover the higher annual expense.
The same can happen if property taxes increase.
As a result, your total monthly mortgage payment can increase even though your fixed mortgage interest rate has not changed.
What Is an Escrow Analysis?
Mortgage servicers generally review escrow accounts periodically to determine whether enough money is being collected to cover upcoming expenses.
This review is often referred to as an escrow analysis.
The servicer looks at:
- Current property tax estimates
- Insurance premiums
- Previous escrow payments
- Upcoming bills
- Required escrow reserves
- Any shortage or surplus
The results can affect your future monthly payment.
What Is an Escrow Shortage?
An escrow shortage occurs when there is not enough money in the escrow account to cover the required expenses.
For example, imagine your servicer originally estimated your annual property taxes at $5,000.
If the actual tax bill increases to $6,000, the escrow account may not have collected enough money to cover the higher expense.
That can create a shortage.
Depending on the situation, the servicer may increase your monthly escrow payment to make up for the shortage and ensure enough money is available for future bills.
What Is an Escrow Surplus?
An escrow surplus occurs when the account contains more money than is needed based on the applicable calculation.
Depending on the circumstances and applicable rules, you may receive a refund or have the surplus applied toward your future escrow requirements.
The specific treatment depends on the mortgage and applicable servicing requirements.
Can Property Taxes Affect Your Monthly Mortgage Payment?
Yes.
Property taxes are one of the most common reasons an escrow-based mortgage payment can change.
If your local property taxes increase, your mortgage servicer may need to collect more money each month to ensure enough funds are available for the next tax bill.
This means your mortgage payment can increase even though your mortgage interest rate has remained unchanged.
Can Homeowners Insurance Increase Your Mortgage Payment?
Yes.
Insurance premiums can change for many reasons, including changes in coverage, property characteristics, insurance costs, and market conditions.
If your homeowners insurance premium increases and the insurance is paid through escrow, your monthly escrow contribution may also increase.
It is therefore important to review your homeowners insurance policy and understand how changes in premiums could affect your overall housing expenses.
What Happens If You Change Homeowners Insurance Companies?
If your homeowners insurance is paid through escrow and you switch insurance companies, your mortgage servicer will generally need the updated policy information.
Make sure the new insurance coverage is properly documented and that your mortgage servicer receives the required information.
Failing to maintain the required insurance coverage could create problems with your mortgage.
If you’re considering switching insurance companies, communicate with your servicer and insurance provider to make sure the transition is handled properly.
Can You Pay Property Taxes Yourself Instead of Using Escrow?
It depends on your mortgage terms and lender requirements.
Some homeowners may have the option to pay property taxes and insurance directly instead of using an escrow account.
However, other borrowers may be required to maintain escrow.
If you are considering removing escrow from your mortgage, contact your mortgage servicer to understand whether you qualify and what requirements apply.
Is Escrow the Same as a Down Payment?
No.
Your down payment is the amount you contribute toward purchasing the home that is not financed through the mortgage.
Escrow is different.
An escrow account is used to collect and hold money for certain property-related expenses, such as property taxes and homeowners insurance.
For example, a homebuyer could make a 10% down payment and still have an escrow account for property taxes and insurance.
These are separate parts of the home financing process.
Does Escrow Increase the Cost of Your Home?
Escrow itself does not necessarily make your property taxes or homeowners insurance more expensive.
Instead, it changes how those expenses are collected and paid.
You are still responsible for the underlying costs, but rather than paying them directly when the bills arrive, you may contribute toward them throughout the year.
Escrow can therefore make budgeting easier without eliminating the underlying property expenses.
How Much Money Is Kept in an Escrow Account?
The amount held in an escrow account depends on the expected property expenses and applicable requirements.
The servicer generally needs enough money to cover upcoming bills while also maintaining an appropriate reserve.
Because taxes and insurance can change, the amount needed in the account can change as well.
This is one reason your escrow payment may be adjusted periodically.
What Should Homeowners Do If Their Escrow Payment Increases?
First, review the escrow analysis provided by your mortgage servicer.
Look at the changes in:
- Property taxes
- Homeowners insurance
- Escrow balance
- Previous monthly payment
- New monthly payment
- Any shortage or surplus
If something appears incorrect, contact your mortgage servicer and ask for an explanation.
You can also review your property tax assessment and insurance premium to determine whether either expense has changed.
How Can You Prepare for Changes in Escrow?
Although escrow can make budgeting easier, homeowners should still be prepared for changes in property-related expenses.
Consider:
- Reviewing your annual escrow statement
- Monitoring property tax changes
- Reviewing your homeowners insurance premiums
- Keeping copies of important mortgage documents
- Asking questions about unexpected payment changes
- Maintaining enough room in your monthly budget for potential increases
Understanding these expenses can help prevent surprises when your mortgage payment changes.
What Happens to Escrow When You Sell Your Home?
When you sell your home and the mortgage is paid off, the remaining escrow balance is generally handled as part of the mortgage payoff process.
Depending on the circumstances, any remaining eligible escrow funds may be returned to you after the loan is paid off and the account is reconciled.
Your mortgage servicer can provide the specific details and timeline for your situation.
Why Understanding Escrow Matters
Escrow can make homeownership expenses easier to manage, but it can also cause confusion when your monthly mortgage payment changes.
The key is understanding that your mortgage payment may include several different components.
Your principal and interest may remain stable on a fixed-rate mortgage, while property taxes and insurance can change.
That means an increase in your total monthly payment does not necessarily mean your mortgage interest rate changed.
It may simply reflect higher property-related expenses.
Conclusion
A mortgage escrow account is designed to help homeowners manage expenses such as property taxes and homeowners insurance by collecting money throughout the year and using those funds to pay the bills when they are due.
Your escrow payment is based on estimated property expenses and can change when taxes, insurance premiums, or other eligible costs change. This can result in an escrow shortage, surplus, or adjustment to your monthly mortgage payment.
Understanding how escrow works can make it easier to understand your mortgage payment and prepare for changes in your housing costs. If you have questions about your escrow account or notice an unexpected change in your monthly payment, contact your mortgage servicer or mortgage professional for clarification.
