Escrow Account Explained: What Every Homeowner Should Know

That extra money in your mortgage payment—the part that's not principal or interest—where does it go? If you have a mortgage, there's a good chance some of your payment goes into an escrow account.

Understanding escrow is essential for every homeowner. It affects your monthly payment, your financial planning, and what happens when taxes or insurance costs change.

What Is an Escrow Account?

An escrow account is a holding account managed by your mortgage servicer. It collects money from you throughout the year, then pays certain bills on your behalf when they come due.

Think of it like a forced savings account for your home-related expenses. Instead of coming up with $4,000 for property taxes once a year, you pay about $333 per month into escrow, and your servicer handles the tax bill.

The servicer doesn't earn interest on your escrow money (in most states), and you don't earn interest either. It's simply held until needed.

What Does Escrow Pay For?

Your escrow account typically covers:

Property taxes - Usually the biggest portion. These are paid to your local government, often semi-annually or annually.

Homeowners insurance - Your annual premium, paid to your insurance company.

Flood insurance - Required if you're in a designated flood zone.

Private mortgage insurance (PMI) - If you put down less than 20%, this might be collected through escrow.

HOA fees - Sometimes, though this is less common.

What escrow doesn't cover: utility bills, maintenance costs, repairs, or any other regular expenses. Those are on you to pay directly.

How Escrow Works

Here's the cycle:

Monthly collection: Your servicer estimates your annual property taxes and insurance, divides by 12, and adds that amount to your mortgage payment.

Cushion requirement: Federal law allows servicers to require a cushion—usually equal to 2 months of escrow expenses. This protects against unexpected increases.

Bill payment: When your property tax or insurance bill comes due, the servicer pays it directly from your escrow account.

Annual analysis: Once a year, your servicer reviews the account. Did they collect enough? Too much? This analysis determines if your payment needs to change.

Your Mortgage Payment Breakdown

Let's look at a real example of how escrow fits into your mortgage payment:

PITI stands for Principal, Interest, Taxes, and Insurance—the total monthly cost of your mortgage.

When people ask "What's your mortgage payment?" they usually mean the PITI, not just the principal and interest portion.

Escrow Shortages and Surpluses

Your escrow payment is based on estimates. When actual costs differ from estimates, you end up with either a shortage or a surplus.

Escrow Shortage

A shortage means there isn't enough money in your escrow account to pay upcoming bills. This typically happens when:

• Property taxes increased (common as home values rise)
• Insurance premiums went up (especially in disaster-prone areas)
• You had a partial year at closing and didn't fund a full cushion

When you have a shortage, you have two options:

1. Pay it in a lump sum - Write a check for the shortage amount
2. Spread it over 12 months - Your servicer divides the shortage across the next year's payments

Example: You have a $1,200 shortage. You can pay $1,200 now, or add $100/month to your payment for the next year.

Plus, your ongoing escrow payment will increase to cover the higher expenses going forward.

Escrow Surplus

A surplus means you overpaid into escrow. This can happen when:

• Tax assessments decreased
• You switched to cheaper insurance
• The servicer overestimated expenses

If your surplus exceeds $50, the servicer must refund it to you. You'll typically get a check within 30 days of the annual analysis.

Can You Cancel Escrow?

Maybe. Whether you can eliminate escrow depends on your lender, loan type, and equity position.

Requirements for Canceling Escrow

• Equity requirement: Usually need 20%+ equity in your home
• Payment history: No late payments in the past 12-24 months
• Loan type: FHA loans require escrow for the life of the loan
• Lender policy: Even if you meet requirements, your lender might not allow it

Pros of Canceling Escrow

• Control your money - Pay taxes and insurance on your own schedule
• Earn interest - Keep funds in a high-yield savings account until bills are due
• Flexibility - Shop insurance without coordinating with your servicer

Cons of Canceling Escrow

• Discipline required - You must save the money yourself
• Risk of lapse - If you miss a payment, your lender might force-place expensive insurance
• Convenience - One payment is simpler than managing multiple bills

Cancellation Fee

Some lenders charge a fee (often 0.25% of your loan balance) to remove escrow. On a $300,000 loan, that's $750. Calculate whether the benefits outweigh this cost.

Escrow vs Non-Escrow Mortgages

Who Should Keep Escrow

• First-time homeowners still learning the ropes
• Anyone who prefers simplicity
• People who might struggle to save for large bills
• FHA borrowers (no choice)

Who Might Consider Canceling

• Experienced homeowners with strong cash management
• Those who want to maximize interest earnings
• Homeowners who shop insurance frequently
• Anyone with substantial equity who qualifies

What Happens to Escrow When You Sell?

When you sell your home, your escrow account gets closed. Here's the typical process:

1. At closing, your mortgage is paid off
2. Within 20 days, the servicer sends you a check for your escrow balance
3. The buyer establishes their own escrow account with their new loan

If you're selling and buying simultaneously, don't count on your escrow refund for your down payment—it usually arrives after closing.

Understanding Your Escrow Statement

Once a year, you'll receive an escrow analysis statement. Key things to check:

• Projected disbursements - Estimates for next year's taxes and insurance
• Cushion amount - The reserve being held (max 2 months)
• Shortage or surplus - What you owe or are owed
• New monthly payment - What your payment will be starting next month

Review this statement carefully. Errors happen. If your tax assessment dropped but your escrow payment increased, something might be wrong.

Frequently Asked Questions

Is escrow required for a mortgage?

Not always. FHA loans require escrow. Conventional loans often require it if you put down less than 20%. Once you have 20%+ equity and meet other requirements, you may be able to cancel.

What happens if I pay my taxes directly when I have escrow?

Don't do this. Your servicer will still pay from escrow, creating a double payment. If you've accidentally done this, contact your servicer immediately.

Can my escrow payment change?

Yes, annually after the escrow analysis. If taxes or insurance costs change, your escrow amount adjusts accordingly. This is why your mortgage payment can increase even with a fixed-rate loan.

Is escrow money refundable if I refinance?

Yes. When you refinance, your old escrow account is closed and the balance is refunded to you. Your new loan will establish a fresh escrow account (and likely require funding at closing).

Why is my escrow payment so high?

Escrow is based on your property taxes and insurance costs, plus a 2-month cushion. If these seem too high, verify your tax assessment is correct and shop for competitive insurance rates.

The Bottom Line

Escrow accounts exist to protect both you and your lender—ensuring property taxes and insurance get paid on time. While they reduce your control over your money, they also provide peace of mind.

Whether you keep escrow or cancel it comes down to personal preference and financial discipline. If you're comfortable managing large annual bills yourself, canceling might make sense. If you prefer the simplicity of one payment, keep it.

Either way, review your escrow statement annually to catch any errors and understand why your payment might be changing.

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Understanding your mortgage is the first step to using your equity wisely. See how much equity you can access with a HELOC.