What is an escrow account?
An escrow account is used to collect and hold funds to pay your property taxes, homeowners insurance premiums or other charges when they become due.
The account is often established for you by your mortgage company when you take out your mortgage. However, if an escrow account was not set up when you took out your mortgage, you may be able to do so now.
Real estate taxes and insurance premiums must be paid regularly — typically, payments are due once or twice a year — and failure to pay these bills on time may cost you money in tax penalties or result in cancellation of your insurance coverage.
What are the benefits of an escrow account?
- An escrow account helps you:
- Manage your budget: You do not have to make lump sum payments when your taxes and insurance are due. You have made monthly payments throughout the year to cover those obligations.
- Gain peace of mind: You don’t need to keep track of when your tax and insurance bills are due. The payments will be made, on time, on your behalf.
- Ensure that your home is protected: With paid-up insurance coverage and taxes, you protect your investment in your home and meet your lender’s requirements.
- Most mortgage companies require an escrow account for mortgages with less than a 20 percent down payment.
How does an escrow account work?
Your monthly mortgage payment includes an amount for property taxes and insurance in addition to the amount you owe for principal and interest.
The amount of your monthly mortgage payment that is for taxes and insurance is placed by your mortgage company into an escrow account. The funds can be used only to pay taxes and insurance on your behalf.
Your mortgage company pays the taxes and insurance bills for you when they are due. Your mortgage company examines any changes in your tax and insurance costs (for example, your local government may change the amount of your real estate taxes). Your mortgage company sends you a statement each year showing the prior year’s activity — amounts collected from you and placed in escrow as well as the payments made on your behalf — and showing any adjustments that may be needed based on changes in your tax and insurance costs.
Here is a simplified example* of how escrow payments are calculated:
Annual real estate taxes: $1,800 ÷ 12 months = $150 per month
Annual property insurance: $720 ÷ 12 months = $60 per month
Total monthly taxes and insurance: $210
So in this example, $210 would be added to your total monthly mortgage payment and applied to your escrow account. You might hear your total monthly mortgage payment referred to as your “PITI” — for principal, interest, taxes and insurance.
Do you have an escrow account?
If you are not sure if you have an escrow account, check your monthly mortgage account statement or contact your mortgage company. Your account statement will typically indicate your “Escrow Balance” and the amount of your total monthly mortgage payment that is applied to escrow.
Should you establish an escrow account?
If you do not have an escrow account, you may want to establish one. Ask your mortgage company for more information.
Want more information?
For more information, talk with your mortgage company to determine if you are setting aside adequate funds in your escrow account or if you should set up an escrow account. Also, the U.S. Department of Housing and Urban Development offers “Frequently Asked Questions about Escrow Accounts for Consumers”.
* The amounts you owe for real estate taxes and insurance will vary — this is a simplified example, and your mortgage company will likely use a more detailed calculation method that considers various factors. Ask your lender for a full explanation and an estimate of the escrow payment on your mortgage