What Is Escrow? A Complete Guide for [Homeowners](/blog/home-insurance-savings)

"Escrow" is one of those words that gets thrown around constantly in real estate but rarely explained clearly. To make things more confusing, it actually refers to two completely different things depending on the context.

This guide explains both types of escrow, walks you through real examples, and helps you handle common escrow problems like shortages, overages, and disputes.

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The Two Types of Escrow

Type 1: Buying Escrow (Transaction Escrow)

When you buy a home, escrow is a neutral third party that holds money and documents until the deal closes. Think of it as a trusted middleman.

Type 2: Monthly Escrow (Escrow Account / Impound Account)

After you buy, your lender may set up an escrow account — a savings account attached to your mortgage that collects money each month for property taxes and homeowner's insurance. Your lender pays those bills on your behalf when they come due.

Both are called "escrow." Both involve someone holding your money. But they serve completely different purposes. Let's dig into each one.

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Type 1: Buying Escrow — How It Works When You Purchase a Home

The Problem Escrow Solves

Imagine buying a home without escrow:

• The seller says, "Give me $400,000 and I'll sign over the deed."
• You say, "Sign over the deed and I'll give you $400,000."
• Neither party wants to go first.

Escrow solves this standoff. A neutral third party (the escrow company, title company, or attorney) holds everything until all conditions are met, then distributes money and documents simultaneously.

The Timeline: What Happens During Escrow

Here's what a typical 30-day escrow looks like:

Day 1: Opening Escrow

• You and the seller sign the purchase agreement
• The real estate agent sends the agreement to the escrow company
• Escrow is officially "opened"
• You receive escrow instructions — a document outlining what everyone needs to do

Days 1–3: [Earnest Money](/blog/earnest-money-explained) Deposit

• You deposit your earnest money (typically 1%–3% of the purchase price) into the escrow account
• This money is held by escrow — not given to the seller
• Example: On a $400,000 home, you might deposit $8,000–$12,000

Days 1–17: Contingency Period

• Home inspection happens (usually within 7–10 days)
• You review HOA documents, disclosures, and preliminary title report
• Your lender orders an appraisal
• If problems come up, you negotiate repairs or credits — or back out with your earnest money returned

Days 7–25: Loan Processing

• Your lender processes your mortgage
• The lender sends loan documents to escrow
• The title company does a title search to confirm the seller actually owns the property and there are no surprise liens

Days 25–28: Signing

• You go to the escrow office (or a mobile notary comes to you) to sign loan documents
• The seller signs the deed
• You wire your remaining down payment and [closing costs](/blog/homebuying-closing-process) to escrow

Day 28–30: Closing and Recording

• The lender sends the loan funds to escrow ("funding")
• Escrow verifies everything is complete
• The deed is recorded with the county recorder
• Escrow distributes the money: seller gets paid, agents get commissions, lender gets repaid (if the seller had a mortgage), and any remaining funds go where they belong
• You get the keys

That moment when the deed is recorded? That's "closing escrow."

What Escrow Actually Costs

Escrow fees vary by location but typically run:

• Escrow/closing fee: $500–$2,000 (often split between buyer and seller)
• Title search and title insurance: $1,000–$3,000
• Recording fees: $50–$250

These are separate from your lender's fees, home inspection, appraisal, etc. They're all listed on your Closing Disclosure form (which you receive at least 3 business days before closing).

What Can Go Wrong in Buying Escrow

Appraisal comes in low. The home appraises for less than the purchase price. Options: seller lowers the price, you pay the difference in cash, you renegotiate, or the deal falls through.

Title issues. The title search reveals a lien, easement, or ownership dispute. The seller must resolve this before escrow can close.

Financing falls through. Your loan gets denied. If you have a [financing contingency](/blog/contingencies-explained), you get your earnest money back. If you waived it, you may lose it.

Buyer or seller gets cold feet. If you back out without a valid contingency, you may forfeit your earnest money (the seller keeps it as compensation for taking the home off the market).

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Type 2: Monthly Escrow — Your Tax and Insurance Account

How It Works

After you close on your home, your lender likely sets up an escrow account (also called an "impound account"). Here's the concept:

Instead of saving up and paying your property taxes and homeowner's insurance yourself, your lender collects a portion of these costs every month as part of your mortgage payment, then pays the bills for you when they come due.

Your Mortgage Payment Breakdown

When you hear "PITI," that stands for:

The T and I portions go into your escrow account.

A Real Example

Let's say your monthly costs are:

• Property taxes: $4,800/year ($400/month)
• Homeowner's insurance: $1,800/year ($150/month)
• PMI (if applicable): $1,200/year ($100/month)

Your lender collects $650/month in escrow (on top of your [principal and interest](/blog/amortization-schedule-guide)).

If your total mortgage payment is $2,150/month, it breaks down like:

• $1,000 → principal
• $500 → interest
• $400 → property taxes (escrow)
• $150 → homeowner's insurance (escrow)
• $100 → PMI (escrow)

The $650 in escrow sits in your escrow account until the bills are due. When your property tax bill comes in November, your lender uses the escrow funds to pay it.

The Escrow Cushion

Federal law (RESPA — the Real Estate Settlement Procedures Act) allows lenders to keep a cushion in your escrow account equal to two months of escrow payments. This buffer protects against unexpected increases in taxes or insurance.

Using our example ($650/month in escrow):

• Required cushion: up to $1,300
• This means your account might have $1,300 "extra" at any given time — that's normal and legal

Escrow Analysis: The Annual True-Up

Once a year, your lender performs an escrow analysis. Here's what happens:

1. They look at how much was collected over the past year
2. They look at how much was actually paid out for taxes and insurance
3. They project next year's costs
4. They adjust your monthly escrow payment accordingly

Three possible outcomes:

Escrow Surplus (overage): You paid in more than needed. If the surplus is $50 or more, your lender must refund it to you. You'll get a check.

Escrow on target: Everything balanced out. No change.

Escrow Shortage: You didn't pay in enough — usually because taxes or insurance went up. Your lender will increase your monthly payment to cover next year's projected costs, PLUS spread the existing shortage over the next 12 months.

Escrow Shortage Example

Last year:

• Lender collected: $7,200 ($600/month × 12)
• Lender paid out: $7,800 (taxes went up)
• Shortage: $600

Next year projections:

• Expected costs: $8,400 ($700/month)
• Plus shortage repayment: $600 ÷ 12 = $50/month

Your new escrow payment: $750/month ($700 for projected costs + $50 to repay the shortage)

This is why your mortgage payment can increase even with a fixed-rate loan. The interest rate is fixed, but taxes and insurance aren't.

Can You Avoid Escrow?

Maybe. It depends on your lender and your loan type:

When escrow is required:

• FHA loans — always
• VA loans — always
• Conventional loans with less than 20% down — almost always
• Conventional loans with 20%+ down — lender's choice (many allow you to opt out)

Pros of managing taxes and insurance yourself:

• You keep control of your money
• You earn interest on the funds until bills are due
• No escrow shortage surprises

Cons:

• You must save and budget for large lump-sum payments (property taxes are often due twice a year)
• If you forget to pay your property taxes, the county can put a lien on your home
• If you forget to pay insurance, your lender will buy "force-placed" insurance — which is much more expensive — and charge you for it

If you want to cancel escrow on an existing loan, contact your servicer. Many will allow it if:

• You have at least 20% equity
• Your payment history is good (no late payments in the past 12 months)
• You pay a one-time waiver fee (typically $200–$500)

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Escrow Problems and How to Fix Them

Problem: Your Mortgage Payment Jumped

Cause: Almost always an escrow shortage or increase in taxes/insurance.

What to do:

1. Read your escrow analysis statement (mailed annually, often in January or February)
2. Check if property taxes increased (look at your county tax bill)
3. Check if insurance premiums increased (call your insurer)
4. If the shortage is large, ask your lender if you can pay the shortage in full upfront to avoid the monthly spread — this lowers your ongoing payment

Problem: Escrow Paid the Wrong Amount (or Missed a Payment)

What to do:

1. Contact your loan servicer immediately
2. Provide [documentation](/blog/heloc-documentation-requirements) (the correct tax bill, the correct insurance premium)
3. Follow up in writing (send a qualified written request per RESPA)
4. If unresolved, file a complaint with the Consumer Financial Protection Bureau (CFPB) at consumerfinance.gov

Problem: Taxes Went Up After You Bought

Property taxes are typically reassessed when a home changes hands. If you bought in a hot market, your first tax bill as the new owner might be significantly higher than what the previous owner paid.

Example:

• Previous owner's assessed value: $300,000 (they bought years ago)
• Your purchase price: $450,000
• Reassessed value: $450,000
• Tax increase: potentially 50%

This is normal, but it can create a large escrow shortage in your first year. Plan for it.

Problem: You Want to Change Insurance Companies

You can switch homeowner's insurance at any time. Here's the process:

1. Get a new policy from a different insurer
2. Make sure the effective date matches (no gap in coverage)
3. Notify your loan servicer of the new policy
4. The servicer will update escrow to pay the new insurer
5. Your old insurer will refund any prepaid premium directly to you

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Escrow at a Glance

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Key Takeaways

1. Buying escrow is a neutral third party that makes sure the home purchase transaction happens fairly. It protects both buyer and seller.

2. Monthly escrow is a forced savings account managed by your lender to pay your property taxes and insurance. It protects the lender (and you) from missed payments.

3. Your mortgage payment can change even with a fixed rate because the escrow portion fluctuates with taxes and insurance.

4. Read your escrow analysis when it arrives each year. It explains exactly why your payment is changing and by how much.

5. If something looks wrong, don't ignore it. Contact your servicer, put it in writing, and escalate to the CFPB if needed.

Understanding escrow removes one of the biggest sources of confusion and frustration in homeownership. It's not complicated once you see it for what it is: other people holding your money and paying your bills on a schedule.

Related Articles

• Property Taxes Explained: How They Work and How to Reduce Them
• How to Challenge Your Property Tax Assessment (And Win)
• [[Down Payment Assistance](/blog/down-payment-assistance-programs) Programs in 2026: Complete Guide](/blog/down-payment-assistance-programs)