What an escrow account is and why your lender holds it

An escrow account is a separate account your mortgage lender holds in your name. The lender collects money from you each month, holds it, and pays your property taxes and homeowners insurance on your behalf when those bills come due. You do not pay these bills directly — the lender pays them from the escrow account using the money you have already given them.

Lenders require escrow accounts because property taxes and insurance protect the lender's investment in your home. If you stopped paying property taxes, the government could foreclose and take the house. If the house burned down uninsured, the lender would lose the collateral securing your loan. By controlling these payments themselves, lenders eliminate the risk that you will skip them.

Escrow is not optional on most mortgages. If you put down less than 20 percent, your lender will require an escrow account as a condition of the loan. If you put down 20 percent or more, you may be able to pay taxes and insurance yourself, though some lenders still require escrow.

Key Takeaways

  • Your lender collects a monthly escrow payment from you, holds the money in a separate account, and pays your property taxes and homeowners insurance when bills arrive.
  • Escrow accounts are required on mortgages with less than 20 percent down and are standard practice even on larger down payments.
  • Your monthly mortgage payment includes principal, interest, taxes, insurance, and sometimes mortgage insurance — the escrow portion covers only taxes and insurance.
  • Lenders adjust escrow payments annually based on actual tax and insurance bills, so your payment may go up or down each year.
  • You can request an escrow analysis from your lender at any time if you believe the payment is incorrect.

How the monthly escrow payment is calculated

Your lender estimates your annual property taxes and homeowners insurance, adds them together, and divides by 12 to get your monthly escrow payment. That amount is added to your principal and interest payment each month. So your total mortgage payment is: principal + interest + escrow (taxes and insurance) + mortgage insurance if applicable.

The estimate is based on the previous year's actual bills or the assessed value of your home at purchase. If you bought a house with a $3,000 annual property tax bill and a $1,200 annual insurance premium, your lender would collect ($3,000 + $1,200) ÷ 12 = $350 per month in escrow. That $350 goes into the escrow account and stays there until the bills are due.

Because tax assessments and insurance rates change, your escrow payment will not stay the same forever. Most lenders review the account once a year, usually around the anniversary of your loan closing, and adjust the payment up or down based on what taxes and insurance actually cost.

When the lender pays taxes and insurance from escrow

Property taxes are typically due twice a year, in spring and fall, though the exact dates depend on your county. Homeowners insurance is usually due once a year. When each bill arrives, the lender pays it directly from your escrow account using the money you have already deposited.

You will receive a statement from your lender showing what was paid and when. You may also receive the original tax bill or insurance bill, or you may not — this varies by lender and by county. The important thing is that the lender is paying on time, which you can verify by checking your escrow statement.

If your escrow account does not have enough money to cover a bill when it arrives, the lender will cover the shortfall and add it to your next escrow payment. This is called an escrow shortage. If your account has extra money left over at the end of the year, the lender may credit it toward next year's payments or refund it to you, depending on the amount and your lender's policy.

The annual escrow analysis and payment adjustments

Once a year, your lender performs an escrow analysis. They look at what you actually paid in taxes and insurance over the past year, compare it to what they collected from you, and decide whether your monthly payment should change.

If taxes or insurance went up, your payment will go up. If they went down, your payment will go down. The lender sends you a statement showing the old payment, the new payment, and the reason for the change. This adjustment takes effect on your next mortgage payment.

Escrow analyses can sometimes reveal a significant shortage — for example, if your property was reassessed and taxes jumped. In that case, your lender may spread the shortage over several months rather than charging it all at once. They will explain the plan in the escrow analysis letter.

What happens if you refinance or pay off the mortgage

When you refinance your mortgage, the old lender closes the escrow account and refunds any balance to you. The new lender opens a new escrow account and begins collecting escrow payments under the terms of the new loan. You will receive a refund check within a few weeks of closing the old loan.

If you pay off the mortgage in full, the lender closes the escrow account and refunds the balance. From that point forward, you are responsible for paying property taxes and homeowners insurance directly to the tax assessor and insurance company. This is one reason people sometimes choose to pay off a mortgage early — they regain control over these payments and can shop for cheaper insurance or understand exactly when taxes are due.

Escrow accounts versus impound accounts

The terms escrow account and impound account mean the same thing in the context of mortgages. Both refer to an account the lender holds to pay taxes and insurance. The terminology varies by region and lender, but the mechanics are identical. Some lenders use "escrow," others use "impound," and some use both interchangeably in their documents.

Do not confuse a mortgage escrow account with an escrow account used in a real estate transaction. During a home purchase, an escrow account temporarily holds the down payment and earnest money until closing. That is a different purpose and a different account, usually managed by a title company or attorney rather than your lender.

Frequently Asked Questions

Can I opt out of escrow if I have a larger down payment?

It depends on your lender and loan type. Conventional loans with 20 percent or more down often allow you to waive escrow, though some lenders still require it. FHA and VA loans typically require escrow regardless of down payment. Ask your lender before closing whether escrow is mandatory or optional on your specific loan.

What if my escrow payment seems too high?

Request an escrow analysis from your lender. They will review your actual tax and insurance bills and recalculate the payment. If the analysis shows an error, the lender will adjust the payment. You can request an analysis at any time, not just during the annual review.

Do I get interest on money sitting in escrow?

No. Escrow accounts do not earn interest in most states. Your lender holds the money without paying you anything for it. Some states require lenders to pay interest on escrow accounts, but the rate is typically very low. Check your loan documents or ask your lender whether your state requires escrow interest.

What if the lender makes a mistake and pays the wrong amount?

Contact your lender when ready with the correct bill amount. The lender is responsible for correcting the error and adjusting your escrow account. If the mistake caused you to overpay, the lender will credit the difference to your account. Keep copies of your tax bills and insurance declarations so you can verify the payments.