What Is an Escrow Account?

A mortgage escrow account, also called an impound account, is an account your loan servicer holds to pay your property taxes and homeowners insurance. Each month, part of your mortgage payment goes into the account, and the servicer pays those bills when they come due. Federal rules limit the extra cushion the servicer can hold to about 2 months of escrow payments and require a review every year, with any surplus of $50 or more refunded to you if your payments are current.

The word escrow also describes a different arrangement during a home purchase, where a neutral party holds money and documents until closing. That is covered at the end of this article.

What does an escrow account pay?

The servicer is the company that collects your payments, and it may or may not be the lender that made the loan. What loan servicing is explains the role. From the escrow account, the servicer typically pays:

• Property taxes, which often come due in one or two large bills a year.
• Homeowners insurance premiums, plus flood insurance if your lender requires it.
• Mortgage insurance premiums, if your loan has them.
• Other property charges in some cases, such as ground rents or special assessments.

Homeowners association dues are often left out of escrow, so you pay them yourself. Your Loan Estimate and Closing Disclosure show which property costs are in escrow and which you must pay separately.

Because tax bills and insurance premiums change, the escrow part of your payment can change each year even when your interest rate is fixed.

When does the lender require an escrow account?

Whether you must have one depends on the loan:

On a higher-priced loan, you can ask to cancel escrow after 5 years only if your balance is below 80% of the home's original value and you are not behind on payments.

If your loan does not require escrow, the Consumer Financial Protection Bureau (CFPB) suggests considering one anyway so the large bills are spread across monthly payments. Without escrow, you pay taxes and insurance yourself. If you miss them, the lender can add an escrow account, add the unpaid amounts to your loan, or buy force-placed insurance and charge you for it.

How is the monthly amount set?

A federal rule under the Real Estate Settlement Procedures Act (RESPA), 12 CFR 1024.17, limits what a servicer can collect:

• Monthly deposit: up to one-twelfth of the taxes and insurance the servicer expects to pay over the next 12 months.
• Cushion: an extra amount for unexpected costs, no more than one-sixth of the year's expected payments, which equals 2 months of deposits.
• Deposit at closing: enough to keep the account from ever going below zero, based on when the bills are due, plus the cushion. This deposit is part of your cash to close.

Your servicer must give you an initial escrow statement at closing or within 45 days after it, listing the monthly escrow amount and the estimated taxes and insurance.

Example: Your property taxes are $4,800 a year and your homeowners insurance is $2,400.

• Annual escrow payments: $4,800 + $2,400 = $7,200.
• Monthly escrow deposit: $7,200 / 12 = $600.
• Largest cushion allowed: $7,200 / 6 = $1,200.

Your total monthly payment is principal and interest plus the $600. What closing costs include shows where the initial escrow deposit appears among other closing charges.

What happens at the annual escrow review?

Once a year, the servicer runs an escrow analysis comparing what came in with what it paid and projecting the next year's bills. It must send you an annual escrow statement within 30 days of the end of the escrow year. The analysis can show three results:

• Surplus: the account holds more than it needs.
• Shortage: the account has money but less than it needs.
• Deficiency: the account balance is negative because the servicer advanced money for you.

What the servicer can do, if your payments are no more than 30 days late:

If you are more than 30 days behind, the servicer can keep a surplus and collect a deficiency under the terms of your loan documents.

Example of a shortage: Your tax bill rises from $4,800 to $5,400, so next year's escrow payments total $7,800 and the new monthly deposit is $650. The analysis also finds a $720 shortage. Because $720 is more than one month's escrow payment, the servicer cannot demand it at once; it can spread it over 12 months at $60 a month. Your escrow deposit becomes $650 + $60 = $710.

What must the servicer do for you?

• Pay bills on time. The servicer must pay taxes and insurance by the deadline to avoid a penalty, as long as your mortgage payment is not more than 30 days overdue. It must advance its own money if the account is short, then recover it through the rules above.
• Return money after payoff. When you pay off the loan, the servicer must refund any escrow balance within 20 days, not counting weekends and federal holidays. If your new loan is with the same lender or servicer, it can move the balance to the new escrow account instead, but only if you agree.

How is a mortgage escrow account different from closing escrow?

When you buy a home, a settlement agent coordinates the closing. Depending on where you live, it is a title company, an escrow company (common in most western states), or a closing attorney (common in some eastern states). The agent collects money from the buyer, the seller, and the lender, then pays the seller and the service providers under the purchase contract and loan terms. That arrangement ends at closing.

The mortgage escrow account starts at closing, when you make the initial deposit, and lasts as long as the loan requires it. For the rest of how a home loan works, see what a mortgage is.