How a Mortgage Escrow Account Works (and Why Your Payment Changes)

A mortgage escrow account is how many homeowners pay property taxes and homeowners insurance without facing a huge bill once or twice a year. Your servicer collects a little extra each month, holds it, and pays the bills for you. This guide explains what escrow covers, the federal limits on how much your servicer can hold, why your payment changes every year, and what to do when something goes wrong.

What is a mortgage escrow account?

An escrow account, also called an impound account, is a separate account your mortgage servicer manages for property-related bills. Each monthly payment includes principal, interest and an escrow amount. The servicer uses the escrow money to pay your property taxes and insurance premiums when they come due (CFPB).

The CFPB notes that many lenders require escrow, and some state laws do too. You can also ask for one even if your lender does not require it, which can make large bills easier to budget for (CFPB). The CFPB also explains the difference between a lender and a servicer, and how to find your servicer (CFPB).

What does escrow pay for?

Escrow mainly pays two bills: your property taxes and your homeowners insurance premium. Depending on your loan, it may also pay other insurance your lender requires, such as flood insurance or mortgage insurance. HOA dues and utilities are usually paid by you directly, not through escrow.

Your escrow statement lists exactly which bills the servicer pays. Read it at closing and every year after, so you know what is and is not covered.

How is your escrow payment calculated?

Your servicer adds up the bills it expects to pay over the next 12 months, divides by 12, and may add a small cushion. The total is the escrow part of your monthly payment. Federal Regulation X (12 CFR 1024.17) sets the rules for how much can be collected.

The cushion limit: about two months

Servicers may hold a cushion, which is extra money to cover small increases or timing gaps. Federal rules cap the cushion at no more than one-sixth of the estimated total annual escrow payments (12 CFR 1024.17(c)). One-sixth of a year is two months, so the cushion can be about two months of escrow payments at most. Your loan documents or state law may set a lower cushion.

A worked example

This example is hypothetical, with round numbers to keep the maths simple.

• Annual property taxes: $4,200
• Annual homeowners insurance: $1,800
• Total yearly escrow bills: $6,000
• Monthly escrow amount: $6,000 ÷ 12 = $500
• Maximum cushion: $6,000 ÷ 6 = $1,000 (two months of $500)

So the escrow part of the payment is $500 a month, and the servicer may keep up to $1,000 as a cushion at the low point of the year.

Why you pay into escrow at closing

Most buyers make an initial escrow deposit at closing. That is because tax and insurance bills do not line up neatly with your first mortgage payment. The servicer needs enough money in the account so that, when the next bill is due, the balance covers it and the cushion stays within the limit. Your initial escrow statement shows the monthly amount, the expected bills and their dates, the cushion, and a month-by-month projected balance.

When you review your closing papers, check three things:

• The property tax figure matches a recent bill or a reasonable estimate for your new assessed value, not an old bill that included the seller’s exemptions.
• The insurance premium matches the policy you actually bought.
• The payment dates match when your county and insurer really bill.

If something looks off, ask your lender or servicer to explain it before or soon after closing. Fixing an estimate early avoids a surprise shortage a year later.

What is an annual escrow analysis?

At the end of each escrow year, your servicer must review the account. It compares what it collected with what it paid, projects next year’s bills, and sets your new monthly escrow amount. The analysis also shows whether you have a surplus, a shortage or a deficiency (12 CFR 1024.17).

Key timing rules under Regulation X:

• Initial statement: you get an initial escrow account statement at closing or within 45 calendar days after it.
• Annual statement: your servicer must send an annual escrow account statement within 30 days after the end of each escrow computation year.

What happens with escrow shortages, deficiencies and surpluses?

After the analysis, your account falls into one of three outcomes. A surplus means there is more money than needed, and you may get a refund. A shortage means the balance is projected to run low. A deficiency means the account actually went negative because the servicer advanced money to pay a bill.

“Current” means the servicer receives your payments within 30 days of the due date. If you are not current, the servicer may be able to keep a surplus under your loan terms (12 CFR 1024.17(f)).

Shortage example

Using the hypothetical example above, suppose your property taxes rise from $4,200 to $4,800. Your yearly escrow bills are now $6,600. Your new base escrow amount is $6,600 ÷ 12 = $550. If the analysis also finds a $600 shortage from last year, spread over 12 months, that adds $50 a month. Your escrow payment goes from $500 to $600 a month until the shortage is paid.

Why do mortgage payments go up?

If you have a fixed-rate loan, your principal and interest do not change. But your escrow amount does. The most common reasons are higher property taxes, higher insurance premiums and a shortage from the prior year (CFPB).

Common triggers include:

• A new assessment. Many new owners see taxes jump after a sale or a reassessment. Our guide on how property taxes work explains why.
• A lost exemption. If the seller had a homestead exemption and you have not applied for your own, your bill may rise. See our homestead exemption guide.
• Insurance renewals. Premiums can change every year.
• Prior-year shortage. The servicer may spread last year’s gap across this year’s payments.

You can sometimes lower the bill at the source. If you think your assessed value is too high, a property tax appeal may help, and shopping your insurance at renewal may lower the premium. Tell your servicer about any new insurer so it pays the right company.

Can you waive or cancel escrow?

Sometimes, but it depends on your loan, your lender and your state. Many lenders require escrow, and some loan programs require it for as long as you have the loan. Ask your servicer what its rules are before you count on paying the bills yourself.

For higher-priced mortgage loans, federal Regulation Z generally requires an escrow account. The servicer does not have to cancel it until at least five years after closing, and then only if you ask, your balance is under 80% of the home’s original value, and you are not behind on payments (12 CFR 1026.35(b)).

If you do drop escrow, you must budget for and pay the bills yourself. The CFPB warns that unpaid property taxes can lead to penalties, a tax lien or even foreclosure. If you do not pay your insurance, your lender may buy force-placed insurance for you, which is usually more expensive (CFPB).

What if your taxes or insurance did not get paid?

Act fast. If you are no more than 30 days behind on your mortgage, Regulation X says your servicer must pay escrow bills on time to avoid penalties (12 CFR 1024.17(k)). If it misses a payment, the CFPB recommends contacting the servicer right away and sending a written notice of error (CFPB).

1. Call your tax office or insurer to confirm what is unpaid and whether coverage is at risk.
2. Contact your servicer and ask it to pay the bill and fix any late fees.
3. Send a written notice of error with a copy of the bill, your loan number and a short description of the problem. Keep a copy and proof of mailing.
4. Watch for force-placed insurance notices. Under Regulation X, a servicer must send a notice at least 45 days before charging you for force-placed insurance, and a reminder at least 15 days before. If you show proof of coverage, it must cancel the policy and refund overlapping charges within 15 days (12 CFR 1024.37).
5. Get help if needed. The CFPB suggests a HUD-approved housing counselor or an attorney if you face foreclosure, and you can file a complaint with the CFPB.

This guide is educational and not legal advice. For problems with a specific loan, a HUD-approved housing counselor can help at no or low cost.