What is a mortgage escrow payment and how does it work?

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A mortgage escrow is an agreement made with your mortgage lender that has a straightforward, two-fold job: hold money, and make home insurance and tax payments for the homeowner. After the transaction is finalized, and the buyer begins making mortgage payments, the escrow account holds a portion of each payment and uses it to pay property taxes and insurance premiums.

With an escrow account your mortgage bill isn’t just paying for the principle and interest on your loan; some of the money is for insurance and property taxes. The lender simply puts this money in the escrow account each month. When the time comes for insurance and taxes to be paid, the escrow service takes care of it for you.

An escrow service is a useful tool for making sure property taxes and insurance costs are paid and in a timely fashion. In a sense, an escrow is an automated payment service that handles the legwork for the homeowner. In many real estate transactions, an escrow account is mandatory because it helps make sure both insurance and taxes get paid.

How Mortgage Escrow Payments Are Calculated

The calculation of the monthly mortgage escrow amount is done by simply taking an estimate of what you have to pay in taxes and insurance and dividing it by 12. This is the amount that is taken from your mortgage payment each month and put into escrow. Most states also require you to have a minimum escrow balance equal to two months worth of escrow payments.

We use the word “estimate” because the amount you actually have to pay may be higher or lower than what’s being kept in escrow. The value of your property is assessed each year, and this is used to calculate your taxes. If the taxes are higher than expected, you may have to pay more.

Conversely, if the taxes end up being lower, you may get a refund from the escrow account. If your estimated tax amount is too low, and you end up owing more than what’s in the escrow account, you can typically spread the payments out over the next year.

Here’s an example of a basic escrow calculation. Let’s say your taxes and insurance for the year break down like this:

  • Property taxes = $3,000
  • Flood insurance = $1,000
  • Homeowners insurance = $800
  • The total amount is $3,000 + $1,000 + $800 = $4,800

This means your escrow amounts will look like this:

  • Total escrow payments = $4,800
  • Monthly escrow payment = $4,800/12 = $400
  • Minimum escrow balance = $400 x 2 = $800

Beware of the Escrow Review

As mentioned, the amount held in escrow is based on an estimate of your property taxes. When your home is reassessed, the amount of money you owe can go up–significantly. When there’s an escrow review, all of a sudden you may end up having to pay a lot more than you expected. Consider this example:

You purchase a home in January 2020. The loan servicer pays your 2020 property taxes in November 2020. A few months later, in January 2021, you get your first escrow review letter, and see that your payment is staying about the same. In November 2021, the loan servicer pays your reassessed property taxes, which have gone up by $600. That means your property taxes went up $600 in 2021.

A few months after that, in January 2022, you get your second escrow review letter. Uh-oh.

The bank needs to collect an additional $600 for property taxes each year. Dividing that by 12 means your monthly payment will increase by $50. But that only accounts for the following year, 2022. What about the $600 tax increase from 2021? That has to be covered, too. Therefore, your monthly escrow payment would increase a total of $100.

There also may be an additional amount tacked on to prevent a similar shortage in the future. But no need to worry. If you end up having more in your escrow account than you owe, you will be entitled to a refund.

Escrow FAQs

What’s it mean it be “in escrow”?

When you make an offer and a deposit on a home, you’re “in escrow.” This means that your deposit is held in an escrow account, which is managed by a third party. It also means that both you and the seller have to fulfill the terms of a contract in order for the seller to get your money and you can take ownership of the property.

What is an escrow account?

When you pay your mortgage each month, some of the money is designated for property taxes and insurance. An escrow account holds that money until it’s time to pay it.

Am I the one who sets up the escrow account?

No. A title agent, loan servicer, or attorney does it for you.

When I close, how much goes into escrow?

Often, it’s two months worth of the estimated property taxes and all insurance payments you have to make. But sometimes you must pay the whole first year of homeowner’s insurance up front. In that case, your escrow payments for that insurance will begin with the next year’s bill.

Is an escrow account mandatory?

Almost always. It protects the lender as well as you from the effects of falling behind on payments. However, if you prefer to pay your taxes in full, and put a 20% down payment on the home, you will not need to set up an escrow account.

Are there any benefits to not having an escrow account?

Yes, if the amount of money you make varies a lot from month to month, you might benefit from putting money for taxes and insurance aside on your own. This way, you could set aside more during good months and vice versa.

Can my escrow account earn interest on my money?

Probably not because most states don’t require interest to be paid. But in the following states, lenders are required to pay interest on money in escrow: Alaska, California, Connecticut, Iowa, Maine, Maryland, Massachusetts, Minnesota, New Hampshire, New York, Oregon, Rhode Island, Utah, Vermont, and Wisconsin.

Can my escrow payments go up?

Yes. This is usually because the amount you owe in property taxes go up. However, they can go down if you end up owing less than was estimated.

What if there’s a mistake, and my escrow account doesn’t pay my taxes and insurance?

It’s your responsibility to make sure all taxes and insurance are paid in full and in a timely fashion. To prevent problems:

  • Check your escrow statements against the tax rates and tax bills, and make sure everything is being paid.
  • Learn how the taxes are calculated in your area.
  • Check the math regarding taxes at closing.

Are my property taxes in escrow tax deductible?

The property taxes you pay are tax deductible. However, the amount you can deduct depends on how much you actually paid, not how much was held in escrow.