How Does an Escrow Account Work?

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If you're getting ready to apply for a mortgage loan, you may have heard something about escrow accounts. Your mortgage servicer may require you to use an escrow account, also called a mortgage impound account, where it will keep money for non-mortgage expenses. The mortgage servicer will then set aside a portion of your monthly payment into the escrow account and use the money to pay the bills on your behalf.

What Is an Escrow Account?

An escrow account is essentially a savings account that your mortgage servicer manages. It's generally a requirement if you have a government-backed mortgage, such as an FHA loan, or a conventional mortgage if you have less than 20% equity.

When you have an escrow account, your monthly mortgage payment is made up of two parts. One portion is what you pay for your mortgage's principal and interest. The other portion gets set aside in your escrow account for property tax and insurance payments. Combined, these are sometimes referred to as principal, interest, taxes and insurance—or PITI.

The escrow account payment portion covers your:

Some mortgage servicers also let you make your homeowners association (HOA) fee payments through your escrow account, but this isn't common.

Mortgage lenders often require that you use an escrow account because it can help protect their investment. By taking control of the property tax and insurance payments, the lender can be sure you won't fall behind on tax payments or let your insurance coverage lapse.

The escrow account will be set up when you first get your mortgage. At that point, you may need to make an upfront payment for up to two months' worth of escrow payments and then pay a minimum balance going forward.

Your monthly escrow payment will be determined by dividing your total annual payment amount into 12 payments. For example, if your property taxes and insurance premiums will be $2,400 over the next 12 months, you'll pay $200 each month. Your mortgage servicer must put these funds into the escrow account and use them to pay the correlated taxes and premiums.

How Do Escrow Reviews Work?

Each year, your mortgage servicer will review your escrow amount and estimated charges for the coming year to determine if there's been a change.

  • When your premiums or taxes increase, your monthly payment will also go up because more money needs to be set aside for your tax and insurance payments. Additionally, an increase can lead to a shortage in your escrow account's reserves. You may have to cover this with a one-time payment, increased monthly payment or a combination of the two.
  • When your premiums or taxes decrease, your monthly payments will go down as well. You may also get a refund for the overage amount that's in your escrow account.

You can learn about changing escrow payment amounts, account balances and your escrow account transaction history in the escrow review statement that your mortgage service should send you each year.

Should You Set Up an Escrow Account?

Depending on the type of mortgage you're trying to get, you may be required to use an escrow account. Even when it's not a requirement, some people prefer having an escrow account because they don't want to budget for property taxes and property-related insurance payments on their own.

If you fall behind on payments, your servicer could pay past-due bills on your behalf and then increase your monthly payment and require you use an escrow account going forward. It may even purchase homeowners insurance on your behalf, called force-placed insurance, which may be more expensive than the policy you had before.

Additionally, lenders may charge you a fee or higher interest rate for mortgages without an escrow account.

Some people prefer to manage their finances on their own and don't want to be forced to use an escrow account, however. Instead, they may set aside the money in a high-yield savings account and earn interest throughout the year. Depending on where you live, your mortgage servicer might be able to keep the interest that accrues in the escrow account.

What Happens to Your Escrow Account After Paying Off Your Mortgage?

Once you pay off your mortgage, your mortgage servicer should close the escrow account and send you any money that's leftover. You'll also now be responsible for making your property tax and insurance payments directly.

You'll want to contact your insurance providers to give them your updated payment information. Additionally, reach out to your local tax office to figure out how you can pay your property taxes and how often they're due.

Prepare for Upfront and Ongoing Escrow Account Payments

As you prepare to buy a home, you'll want to consider how much you'll have to pay for property taxes and insurance. While you'll need to make these payments whether or not you have an escrow account, know that these may be included in the monthly payment that you send to your mortgage servicer. Additionally, plan to make up to two months' worth of escrow payments as part of your closing costs.