When you make a mortgage payment each month, you may notice that part of the payment goes toward more than just your loan principal and interest.
Depending on your mortgage, your monthly payment may also include money for property taxes and homeowners insurance.
This is where a mortgage escrow account can come into play.
An escrow account allows money to be collected as part of your monthly mortgage payment and then used to pay certain property-related expenses when they are due.
Understanding how mortgage escrow works can help you better understand your monthly payment and avoid surprises when your property taxes or insurance costs change.
What Is Mortgage Escrow?
A mortgage escrow account is an account used to hold money for certain expenses associated with owning your home.
The money is generally collected from you as part of your monthly mortgage payment and then used to pay eligible expenses when they come due.
Common expenses paid through escrow include:
- Property taxes
- Homeowners insurance
- Flood insurance, when required
- Other eligible insurance or property-related expenses
Instead of having to save separately and make a large property tax or insurance payment when it is due, the cost can be divided across your monthly mortgage payments.
Your mortgage servicer then uses the money in the escrow account to make the required payments.
How Does a Mortgage Escrow Account Work?
Suppose your annual property taxes and homeowners insurance total $6,000.
Instead of paying the entire amount yourself when the bills come due, your mortgage payment could include approximately $500 per month toward these expenses.
That money is placed into your escrow account.
When your property tax or insurance bill becomes due, the mortgage servicer uses the money in the account to make the payment.
Your actual escrow amount will depend on your property’s taxes, insurance costs, payment schedule, and other factors.
The goal is to collect enough throughout the year to cover the expenses when they are due.
What Is Included in an Escrow Payment?
Your escrow payment can vary depending on the expenses associated with your property.
The most common items are property taxes and homeowners insurance.
Property Taxes
Property taxes are generally paid to your local government and help fund services such as schools, roads, public safety, and other community services.
If your property taxes are included in your escrow account, your mortgage servicer collects a portion of the estimated annual tax bill through your monthly payment.
The servicer then uses the escrow funds to pay the tax bill when it is due.
Homeowners Insurance
Homeowners insurance protects your property against certain covered losses and is commonly required by mortgage lenders.
If your homeowners insurance is included in escrow, part of your monthly mortgage payment is set aside to cover the premium.
The servicer then pays the insurance bill from the escrow account when it becomes due.
Other Insurance or Property Expenses
Depending on the property and loan requirements, other expenses may also be included in escrow.
For example, a borrower in an area where flood insurance is required may have that insurance premium included in the escrow calculation.
The specific expenses depend on the mortgage and property.
Why Do Lenders Use Escrow Accounts?
An escrow account can make it easier for homeowners to manage large annual or semiannual expenses.
It also gives the lender additional protection because property taxes and required insurance are paid on time.
If property taxes are not paid, the property could potentially be subject to a tax lien.
Likewise, allowing required homeowners insurance to lapse could create additional risk for both the homeowner and lender.
By collecting money throughout the year, an escrow account helps ensure these important expenses are funded when they come due.
Does Every Mortgage Have an Escrow Account?
No.
Whether an escrow account is required or available can depend on the type of mortgage, lender requirements, property, down payment, and other circumstances.
Some borrowers may be required to have an escrow account, while others may have the option to pay certain property expenses directly.
If you are unsure whether your mortgage includes escrow, check your mortgage documents or ask your lender or mortgage servicer.
Your monthly mortgage statement should also provide information about how your payment is being allocated.
Why Can Your Escrow Payment Change?
One of the most confusing parts of escrow for homeowners is that the escrow portion of their monthly payment can change.
Your principal and interest payment on a fixed-rate mortgage may remain the same, but your total monthly payment can still increase or decrease because property taxes and insurance costs can change.
For example, imagine your property taxes increase after a local reassessment.
Your mortgage servicer may need to collect more money each month to have enough funds available for the next tax bill.
The same thing can happen if your homeowners insurance premium increases.
This can cause your total monthly mortgage payment to change even though your mortgage interest rate has not changed.
What Is an Escrow Analysis?
Mortgage servicers generally review escrow accounts periodically to determine whether enough money is being collected to cover upcoming expenses.
This review is commonly called an escrow analysis.
The servicer compares the amount currently being collected with the expected property taxes, insurance premiums, and other eligible expenses.
If the projected costs have increased, your monthly escrow payment may increase.
If the projected costs have decreased, your escrow payment may decrease.
The analysis can also identify whether your account has a shortage or surplus.
What Is an Escrow Shortage?
An escrow shortage happens when there is not enough money in your escrow account to cover the required property expenses.
For example, your property taxes may have increased more than expected during the previous year.
If your servicer does not have enough money in the account to pay the full bill, the account may show a shortage.
Your mortgage servicer may then adjust your future escrow payments to account for both the higher expected expenses and the shortage.
This is one reason homeowners sometimes receive a notice explaining that their monthly mortgage payment is increasing.
What Is an Escrow Surplus?
An escrow surplus is generally the opposite of a shortage.
It can occur when more money was collected than needed for the projected expenses and the account has more funds than required under applicable rules.
Depending on the circumstances and applicable requirements, the servicer may refund the surplus or apply it according to the rules governing the escrow account.
If you receive an escrow analysis showing a surplus, review the information to understand why your account has more money than expected.
Can You Avoid an Escrow Account?
In some situations, borrowers may have the option to pay property taxes and homeowners insurance themselves instead of using an escrow account.
However, whether this is available depends on the mortgage, lender requirements, loan program, property, and other factors.
Before choosing to waive escrow, consider whether you are comfortable managing these expenses yourself.
Without escrow, you may need to set aside money throughout the year and make sure large tax and insurance bills are paid on time.
For some homeowners, managing these payments independently can be convenient.
For others, escrow provides a simpler way to budget for recurring property expenses.
What Are the Advantages of Having an Escrow Account?
Escrow can make homeownership easier to manage in several ways.
Easier Monthly Budgeting
Instead of preparing for a large property tax or insurance bill, the cost is divided into smaller monthly amounts.
Fewer Large Payments
You do not have to set aside a large amount of money immediately before a tax or insurance bill is due.
Payments Are Managed for You
Your mortgage servicer generally handles the payment of eligible escrow expenses when they become due.
Helps Prevent Missed Property Bills
Having funds collected throughout the year can make it easier to ensure important property expenses are paid on time.
What Should Homeowners Watch for With Escrow?
Although escrow can simplify budgeting, homeowners should still review their escrow information.
Pay attention to changes in:
- Property taxes
- Homeowners insurance premiums
- Flood insurance
- Monthly escrow payments
- Escrow shortages or surpluses
- Annual escrow statements
If your mortgage payment suddenly changes, do not assume that your interest rate changed.
Review the statement to determine whether the change came from your principal and interest payment, escrow, mortgage insurance, or another expense.
How Can You Better Prepare for Escrow Changes?
The best way to prepare for an escrow change is to understand what expenses are included in your account.
Keep track of your property tax assessments and homeowners insurance renewal information.
If you receive notice that your insurance premium or property taxes are increasing, remember that the change could eventually affect your monthly mortgage payment if those expenses are paid through escrow.
You may also want to maintain some savings beyond your regular mortgage payment.
That can give you more flexibility if your property taxes, insurance costs, or other homeownership expenses increase unexpectedly.
How The Faille Team Can Help
Understanding your mortgage payment involves more than knowing your principal and interest.
Your total payment may also include property taxes, homeowners insurance, mortgage insurance, and other expenses depending on your loan and property.
The Faille Team can help borrowers understand the different components of a mortgage and explore financing options based on their individual circumstances.
If you are buying a home and have questions about escrow, monthly payments, or the overall cost of your mortgage, discussing your options with a mortgage professional can help you better understand what to expect.
Conclusion
Mortgage escrow is a system that helps homeowners manage certain recurring property expenses by collecting money as part of their monthly mortgage payment.
Property taxes and homeowners insurance are among the most common expenses paid through escrow.
While escrow can make budgeting easier, your escrow payment can change when property taxes, insurance premiums, or other expenses change.
That is why it is important to review your mortgage statements and escrow information regularly.
Understanding how your escrow account works can help you better understand your total mortgage payment, prepare for potential changes, and avoid surprises as you manage the costs of owning a home.
