What is an escrow account? Do I have one?

An escrow account is how your mortgage lender ensures that your property taxes and insurance are paid on time.

If you have a mortgage, you likely have a mortgage escrow account.

Look on a recent statement or bill. If there’s a line or section for “escrow,” part of your monthly payments have been going into your mortgage escrow account.

What is a mortgage escrow account?

It’s an account maintained by your lender to collect funds from you in order to pay the taxes and property insurance due on your home.

Why is a mortgage escrow account needed?

Like you, your lender has a vested interest in your property. As a condition of your mortgage, you agreed to maintain sufficient hazard insurance coverage. If your home gets damaged or destroyed, the hazard insurance will allow the bank to rebuild the home and then either continue with the scheduled mortgage payments or sell it to recoup the outstanding mortgage balance. An escrow account is a way for a bank to ensure that obligations such as taxes and insurance are paid on a timely basis.

Paying your mortgage: Do you have to have an escrow account?

Some lenders will allow you to pay your taxes and insurance on your own. But some loans, such as those guaranteed by the Federal Housing Administration (FHA), require you to establish a mortgage escrow account for these expenses.

Banks often use a loan-to-value (LTV) ratio to determine whether your loan will require an escrow account. This is the ratio of how much you still owe on your home to the appraised value of your home. If your LTV is over 80 percent, some lenders might require an escrow account. If it’s less, they could waive the requirement.

How does a mortgage escrow account work?

If your lender requires a mortgage escrow account, they will calculate how much you’ll need to pay for insurance and taxes each year and divide it by 12 months. That amount is added to the mortgage payment you make each month.

With each mortgage payment you make, the lender deposits the escrow portion of the payment into the escrow account and makes the insurance and tax payments on your behalf from that account as they come due.

You may also be obligated to pay an “escrow cushion.” An escrow cushion consists of funds the lender requires you to pay into the escrow account so that if the taxes or insurance are higher than estimated, the cost is covered. Typically, on a refinance, the cushion is usually around 6 months, which depends on when the payments are due.

What is an escrow overage?

Annually, your lender will perform an examination of your escrow account to make sure it is collecting the correct amount of money for the anticipated expenditures on your taxes and insurance. This analysis determines if there may be an overage, meaning that your escrow account is projected to have more than the minimum balance required at its lowest point in a 12-month period.

If an overage is projected, an adjustment in your monthly payment will be made and, provided the overage is over $50, you will receive a reimbursement check. If the overage is less than $50, your monthly payment will be prorated.

What is an escrow shortage?

A shortage means your escrow account has insufficient funds than are required to make all the necessary payments. This is common when there is an unanticipated increase in your property taxes or insurance.

Another instance where a shortage may take place is when a tax payment is owed by the 15th of the month, so the disbursement occurs a month earlier than anticipated to avoid the possibility of a late fee. An earlier disbursement may also occur if the taxing authority provides a discount for early payments.

Lastly, if there is a change in insurance companies during the 12-month escrow cycle, that change may cause an earlier disbursement date than previously projected.

What happens when there is a shortage?

If a shortage occurs, it will be divided by 12 months and added to the mortgage payment unless paid in full by the borrower prior to the payment change date.

If you pay the shortage in full, will your monthly payments still increase?

Typically, yes. To avoid the same shortage from occurring over the next 12 months, your new monthly escrow deposit will be calculated on 1/12th of the current tax and insurance payments in addition to the escrow cushion.

Why do I have an increase in my monthly payment?

If your taxes or insurance went up in the previous year, the escrow portion of your payment is likely to go up as well when you’re paying your mortgage. Please remember that your monthly escrow deposit is calculated on 1/12th of your current tax and insurance payments to determine your new monthly payment, regardless of your escrow account balance. The escrow cushion is also part of this payment.

Learn more about escrow and how it works within the home-buying process at U.S. Bank.