Your monthly mortgage payment may cover more than just the amount you borrowed and the interest charged by your lender. For many homeowners, the payment also includes money collected for property taxes and homeowners insurance.
These funds are often managed through a mortgage escrow account.
Understanding how escrow works can help you better understand your monthly housing costs, why your payment can change over time, and what happens when your property taxes or insurance premiums change.
What Is a Mortgage Escrow Account?
A mortgage escrow account is an account used to hold money that will later be used to pay certain property-related expenses.
Instead of paying some of these bills separately, your mortgage servicer may collect a portion of the expected expenses with each monthly mortgage payment.
The money is then held in the escrow account until the applicable bills are due.
Common expenses paid through escrow include:
- Property taxes
- Homeowners insurance
- Certain other property-related expenses, depending on the loan and applicable requirements
Escrow does not represent additional money that you owe beyond these expenses. Instead, it is a way of spreading those costs throughout the year.
How Does Mortgage Escrow Work?
Suppose your annual property taxes and homeowners insurance total $6,000.
Rather than paying the entire amount when each bill comes due, your mortgage servicer could collect approximately $500 per month toward those expenses, subject to the actual escrow requirements and applicable calculations.
Your monthly mortgage payment may therefore include:
- Principal
- Interest
- Property taxes
- Homeowners insurance
- Other applicable amounts
The tax and insurance portions are deposited into the escrow account and used when the bills become due.
Why Do Lenders Use Escrow Accounts?
Escrow can help ensure that important property expenses are paid on time.
Property taxes and homeowners insurance are important to both the homeowner and the lender. Unpaid property taxes can create serious problems, while a lapse in homeowners insurance can leave the property inadequately protected.
By collecting these expenses as part of the mortgage payment, the servicer can manage the payments on behalf of the borrower.
Escrow can also make budgeting easier because homeowners do not have to come up with a large annual or semiannual tax bill all at once.
Is Escrow Required for Every Mortgage?
Not necessarily.
Whether an escrow account is required can depend on factors such as the mortgage program, loan characteristics, down payment, property type, lender requirements, and applicable rules.
Some borrowers may have the option to manage property taxes and insurance themselves rather than using an escrow account.
If you are getting a mortgage, ask your lender whether escrow will be required and how it will affect your monthly payment.
What Is Included in an Escrow Payment?
The specific expenses included can vary.
The most common are:
Property Taxes
Property taxes are generally paid to the applicable local taxing authority.
Because the amount can change from year to year, your escrow payment may also need to change.
Homeowners Insurance
Your mortgage servicer may collect money for your homeowners insurance premium and use the escrow account to pay the insurer when the premium is due.
Insurance premiums can also change, which may affect your monthly mortgage payment.
Other Applicable Expenses
Depending on the property and loan arrangement, other expenses may potentially be handled through escrow.
Your mortgage servicer can explain exactly what your escrow account covers.
Why Can Your Mortgage Payment Change If You Have a Fixed-Rate Mortgage?
A fixed-rate mortgage generally keeps the principal and interest portion of your payment consistent.
However, your total monthly mortgage payment can still change if the amounts collected for escrow change.
For example, if your property taxes increase, the amount needed to fund your escrow account may increase as well.
The same can happen if your homeowners insurance premium increases.
This means a homeowner with a fixed-rate mortgage can still see changes in the total amount paid each month.
What Is an Escrow Analysis?
Mortgage servicers periodically review escrow accounts to determine whether the amount being collected is sufficient to cover upcoming expenses.
This review is commonly called an escrow analysis.
The servicer compares the amount currently being collected with the expected property tax and insurance bills.
If the analysis shows that the account may not have enough money, the monthly escrow payment may increase.
If there is an excess balance under the applicable rules, the borrower may receive a refund or have the payment adjusted.
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 property taxes increase unexpectedly. The amount originally collected each month may no longer be enough to cover the new tax bill.
Your servicer may then determine that your escrow account has a shortage.
Depending on the circumstances, you may be given options for addressing the shortage, such as paying an amount upfront or having the shortage incorporated into future payments.
What Is an Escrow Surplus?
An escrow surplus occurs when the account contains more money than is needed under the applicable escrow calculations.
Whether a surplus results in a refund or another adjustment depends on the circumstances and applicable rules.
If you receive an escrow statement, review it carefully so you understand why your payment or account balance changed.
What Happens If Property Taxes Increase?
If your property taxes increase, your mortgage servicer may need to collect more money each month to ensure enough funds are available when the next tax bill is due.
For example, if your annual tax obligation increases by $600, the amount needed for escrow could increase by approximately $50 per month when spread across 12 months, subject to the servicer’s actual calculation.
This is one reason homeowners should not assume their total monthly mortgage payment will remain exactly the same for the entire life of the loan.
What Happens If Your Homeowners Insurance Premium Increases?
The same general concept applies to homeowners insurance.
If your annual premium increases, your mortgage servicer may adjust the amount collected for escrow.
Insurance costs can change for a variety of reasons, including changes to the policy, property characteristics, coverage, or insurance market conditions.
Reviewing your insurance renewal information can help you understand why your escrow payment may have changed.
Can You Avoid an Escrow Account?
In some situations, borrowers may be able to pay property taxes and homeowners insurance directly rather than through escrow.
However, this depends on the mortgage terms and applicable requirements.
Avoiding escrow does not eliminate the expenses. It simply changes how and when you pay them.
Without escrow, homeowners need to budget carefully for potentially large tax and insurance bills.
How Can Homeowners Manage Escrow Effectively?
Even if your mortgage servicer handles your escrow account, it is still a good idea to understand what is happening with your money.
Review Your Escrow Statements
Check your escrow statements when they arrive.
Look for changes in property taxes, insurance premiums, projected balances, and monthly payment amounts.
Monitor Property Tax Changes
If your local property taxes change, your mortgage payment may eventually reflect that change.
Understanding your tax bill can help you anticipate adjustments.
Review Your Insurance Premium
Pay attention to your homeowners insurance renewal.
A change in your premium can affect your escrow requirements and total monthly mortgage payment.
Keep Some Savings Available
Escrow helps spread certain expenses across the year, but homeowners should still maintain emergency savings.
Unexpected repairs and other homeownership costs are generally not covered by an escrow account.
Does Escrow Affect Your Mortgage Balance?
No.
The money collected for escrow is separate from the principal balance of your mortgage.
Your principal balance decreases as you make payments toward the loan principal. Escrow funds are instead held to pay eligible property-related expenses.
This distinction is important when reviewing your mortgage statement because not every dollar included in your total payment reduces what you owe on the loan.
Final Thoughts
A mortgage escrow account can simplify the process of paying property taxes and homeowners insurance by spreading those expenses across your monthly mortgage payments.
However, understanding escrow is important because changes in taxes or insurance costs can affect your total monthly payment even when you have a fixed-rate mortgage.
If your escrow payment changes, review the escrow analysis and supporting information from your mortgage servicer. Understanding where your monthly payment goes can help you budget more accurately and plan for the ongoing costs of homeownership.
