Escrow

An escrow account (in the context of mortgages) is a segregated account held by your mortgage servicer that collects a portion of your monthly mortgage payment to pay property taxes and homeowner's insurance when those bills come due. The servicer acts as a third party — you pay monthly into escrow, and the servicer ensures bills are paid on time on your behalf.

The word "escrow" describes any arrangement where a third party holds funds or documents during a transaction until conditions are met. In real estate, the term applies in two contexts:

1. Closing escrow: During the purchase process, the escrow company holds your earnest money deposit and coordinates the exchange of funds and documents at closing. This is a temporary arrangement.

2. Mortgage escrow account: An ongoing impound account that collects monthly deposits for property taxes and insurance for the life of the loan (or until escrow is removed after reaching 80% LTV on conventional loans).

Most lenders require escrow accounts for mortgages with less than 20% down payment because taxes and insurance protect their collateral — if a borrower fails to pay property taxes, the government can seize the home; if there's no insurance and the home burns down, the lender's collateral is gone. Escrow guarantees these critical bills are paid.

At closing, escrow deposits are collected upfront — see the Closing Costs Calculator to estimate how much your escrow setup will add to your cash-at-closing requirement.

Monthly escrow payment:

Monthly Escrow = (Annual Property Tax + Annual Insurance Premium) ÷ 12

Escrow cushion (maximum allowed):

Cushion = (Annual Property Tax + Annual Insurance Premium) × 1/6

Total monthly mortgage payment (PITI):

PITI = Principal + Interest + (Property Tax ÷ 12) + (Insurance ÷ 12)

Home value: $350,000 · Annual property tax: $4,200 (1.2% effective rate) · Annual homeowner's insurance: $1,400

Monthly escrow = ($4,200 + $1,400) ÷ 12 = $467/month

Maximum cushion the lender can hold = $5,600 × 1/6 = $933

At closing, collected deposits: 3 months property tax ($1,050) + 2 months insurance escrow ($233) + 1 year insurance premium ($1,400) = $2,683 in escrow-related closing items

Monthly mortgage at 7% on $280,000 (20% down): $1,863 P&I + $467 escrow = $2,330 PITI

• Escrow shortage vs. surplus: Annual escrow analysis recalculates monthly deposits based on actual bills. A shortage means your account will go negative — causing a payment increase. A surplus of over $50 is refunded to you.
• Pay shortage upfront to avoid payment increase: If you receive a shortage notice, paying the full shortage as a lump sum prevents the per-month increase from spreading into your payment for the following year.
• Escrow removal at 20% equity: Once your LTV drops below 80% on a conventional loan, you can typically request escrow removal and take responsibility for paying taxes and insurance directly. This requires setting aside money yourself each month.
• FHA loans maintain escrow: FHA-insured mortgages require escrow for the life of the loan regardless of equity position — this is a condition of FHA insurance.
• Escrow accounts are not savings: Funds in your escrow account earn minimal or no interest (regulations vary by state on whether servicers must pass through interest). The account exists purely to ensure tax and insurance bills are paid.