What is a Mortgage Escrow Account?
How does escrow work for a mortgage?
A mortgage escrow (or “impound”) account ensures that a borrower’s annual tax and insurance funds are included in the monthly budget and available when due. As part of your loan closing, you will receive a detailed review of escrow (in your loan estimate). And going forward, if you take a look at your mortgage statement, you can see it as a line item.
The reason your escrow money lives in a separate account is so a third party can pay property taxes and insurance premiums. More importantly, though, it helps borrowers by evenly spreading insurance and tax expenses over 12 payments instead of one lump sum.
Let’s consider an example. Say your annual property taxes are two payments of $1,000 each, and your yearly insurance is $600. Direct payment once a year would require a $2,600 payment. With escrow, though, you can expect to make smaller, monthly payments of $217.
According to the Consumer Financial Protection Bureau (CFPB), you can be required to pay a part of the estimated annual total in advance, but no more than a maximum of one-sixth of the total (this gives you a two-month “cushion”). On top of the cushion, every month, your servicer can require you to pay one-twelfth of the total annual escrow payments the servicer reasonably anticipates paying out of the escrow account.
Is mortgage escrow necessary?
Not always. If your loan-to-value (LTV) is below 80% and you have a record of on-time payments, it may not be a requirement.* It also depends on the loan program you select. Government loans like a VA loan or FHA loan often require escrow accounts because they are guaranteed. You’ll need to do your research on lenders and loan programs if you feel strongly about having a mortgage escrow.
Before waiving or canceling your escrow account, consider these issues.
What is an escrow account used for?
As we mentioned above, a third party will use your escrow account to pay insurance premiums and property taxes. Mortgage escrow allows you to spread these payments out throughout the year instead of having to make one large payment. Many homeowners find that their impound account is the best way to pay property taxes.
How can I set up an escrow account?
Let's say you want to figure out how to set up an escrow account yourself. Before doing anything else, determine the annual cost for homeowner's insurance and property taxes. Then divide that number by 12 for the minimum amount you'll be responsible for every month.
Keep in mind that most mortgage servicers today set up a mortgage escrow account on behalf of their clients. However, if that's not the case with your situation, take some time to research account options through various financial institutions. Once you make a decision and the first few payments, follow up with your escrow company to ensure they're staying current with these funds.
Are there escrow account fees?
Expect to pay an escrow account fee of about 1% of your home sales price at the time of closing. You may also choose to split the fee with the seller, or have the seller pay it altogether. Talk with your real estate agent to see how to best handle these fees.
How to remove an escrow account from a mortgage
Many homeowners look into paying their property taxes separately from their mortgage. Those interested in doing so must notify their loan servicer and request an escrow waiver. Just know that you'll still be on the hook for your property taxes even if you no longer have escrow funds pulled from your monthly mortgage payments.
Should I pay off my escrow balance?
While you may have the option to pay down the principal balance on your mortgage, you do not have the same option when it comes to your escrow account. Homeowners should know that any surplus escrow funds will simply be added to the account by your lender. However, putting more money toward your mortgage escrow could help prevent a shortage of funds in the future.
Can my mortgage escrow amount increase?
Yes. There must always be enough money in your account to cover property taxes and insurance. If there is a tax reassessment or a change in coverage, you may see an increase in payments, resulting in more dollars that need to be available in escrow.
How often is my escrow analyzed?
Annually. At the end of each year, you can expect your lender will review your escrow, property taxes, and insurance to see if your current account will cover the upcoming year’s payments. Know that lenders can collect an extra two months of escrow as protection in case your taxes or insurance are higher than expected.
What is an escrow balance refund?
Lenders are also required to pay you a refund at the end of the year if there is an overage — meaning you have more than the minimum balance in your escrow account. This may happen if your taxes or insurance premiums were less than what was expected.
*FHA, VA, Conventional, and USDA loan requirements are subject to change. Jumbo and non-QM loans may be temporarily unavailable. As a result of COVID-19, mortgage investors are unable to support as many loans, meaning underwriting guidelines for government and conventional loans are becoming more strict.