How Mortgage Escrow Works

Mortgage escrow can be a confusing topic when it comes to home investment. That’s why we’ve broken down commonly asked questions about mortgage escrow so you can be informed as you choose a lender and take the next step toward homeownership.

What is an escrow account?

Mortgage escrow is a process where additional funds are collected with your mortgage payments to pay for other expenses associated with homeownership. The additional money is set aside by your mortgage servicer and used to pay property taxes, home insurance premiums and flood insurance premiums, if you have them, so you don’t have to scramble to pay a large tax bill or insurance premium all at once later on. The payments are made directly by your mortgage servicer when the payment is due.

Is mortgage escrow required?

Different lenders may have different guidelines and regulations concerning mortgage escrow, so be sure to ask about mortgage escrow when you’re searching for the right lender. Not all lenders will require escrow accounts for each customer, and one may be optional for a conventional mortgage if your down payment is higher than 20%. However, your loan type may require it. Many government-sponsored home loans like an FHA or USDA loan do, no matter your down payment amount.

How is escrow determined?

To determine your escrow amount, your lender or mortgage servicer will add your annual property tax and insurance premium amounts together and divide that number by 12.

The amount that is calculated will be the monthly amount you pay to your escrow account for the annual expenses. However, the calculation can be different if you choose a lender with a different payment frequency, like bi-monthly. How are escrow accounts managed?

The amount in your escrow account can vary during the year as payments are made and because of tax assessments and insurance premium adjustments. Lenders will typically cover any shortfalls until they can adjust your monthly payment to make up for tax and insurance premium increases but be sure to ask you lender how they handle escrow shortfall situations.

Keep in mind that your monthly escrow payment also may fluctuate from year to year based on these tax and insurance premium adjustments. Talk to the lender you choose about how your escrow will be managed.

What’s a minimum balance on an escrow account?

A minimum balance on an escrow account is a specified minimum amount you will need to keep in your account to be sure there will be enough money in case of increases in taxes or insurance premiums. There is also a limit on how much your mortgage lender can have you keep as a minimum balance and pay each month for escrow. Before your loan closes, the lender you chose will estimate the total amount of your annual expenses to determine your escrow minimum balance.

Your lender may require you to pay as much as two months’ worth of the total annual taxes and insurance premiums each month, providing you with an escrow cushion, but that is the maximum amount they can ask you to pay.

What is an escrow review?

An escrow review or escrow analysis is when your lender or mortgage servicer reviews your escrow account after 12 months and compares the account to your current bills for taxes and insurance. This helps identify if your escrow account matches the bills or if you have a shortage or surplus.

A shortage in your escrow account is when you don’t have enough funds in escrow because of an increase in taxes or insurance premiums. If you have a shortage, you will be responsible for paying the difference of the funds needed to cover taxes and insurance. However, you will have the choice to either pay the entire amount in one sum or to spread it out over the year.

A surplus in your escrow account typically happens if taxes go down or if the original estimate of your payments was too high. If you have a surplus, your lender or mortgage servicer may pay the appropriate amount to cover taxes and insurance bills from the money in your escrow account, and you will be refunded the remaining amount.

If you have questions or concerns about your escrow account, you should contact your lender or mortgage servicer. For easy-to-read information about an escrow account, visit the Consumer Financial Protection Bureau.

Want to learn more about where your escrow goes? Check out our helpful guides to property taxes, homeowner insurance and more in our Studio blog’s Homeownership section!