What is an
Escrow Account?

In the U.S., an escrow payment: is common term referring to the portion of the mortgage payment that is designated to pay real property taxes and hazard insurance. It is an amount “over and above “the principal and interest portion of a mortgage payment. Since the escrow is used to pay the taxes and insurance, it is referred to as "T & I," while the mortgage payment consisting of principal and interest is called "P&I." The sum total of all elements is then referred to as “PITI: Principal, Interest, Taxes and Insurance." Some mortgage companies and banks require customers to maintain an escrow account that pays the property taxes and hazard insurance. Others offer it as an option for customers. Some types of loans, most notably Federal Housing Administration (FHA) loans and Veteran Loans (VA) will most likely always require the lender to maintain an escrow account for the life of the loan.

Even with fixed interest rate: monthly mortgage payments may change over the life of the loan due to changes in property taxes and insurance premiums. For instance: if hazard insurance premium increases by $120.00 per year, the escrow payment will need to increase by $10.00 per month to account for this difference (in addition to collection for resulting escrow shortage when the lender paid the $120.00 more for the hazard insurance premium than what was anticipated). Per the Real Estate Settlement Procedures Act (RESPA) guidelines the escrow payment must be recomputed at least once every twelve months to account for any increases or decreases in property taxes and hazard insurance. This is called escrow analysis.

To get an idea of what your monthly escrow payment will be, simply add up all these charges and divide by 12. For example, if your annual tax bill is $2,000 and your hazard insurance premium for the year is $600, then your escrow payment will be $216.67 per month, or $2600 divided by 12.

Also realize that the law allows lenders to maintain a “cushion” of no more than one-sixth of the total amount paid out of the account- two months’ worth of payments- so that the escrow account always has a balance. Remember, your escrow payment could change every year if your taxes or hazard insurance costs go up, or if the cushion amount needs adjusting.

Once a year lenders will do an escrow analysis just to make sure you are on track with the amount that you are paying for your escrow account. If there is a shortfall in your escrow your lender is likely to offer some options to make up the difference, For example, you can pay the shortfall in full or via 12 payments over the following year. If there is a surplus in your escrow account, it will depend on the size of the overage. Above a certain amount, the lender will write you a check. For smaller surpluses, the lender will apply it to the next year’s escrow payments.

If you do not have a government loan (FHA, VA), you can stop paying escrow altogether if you have at least 20% of your mortgage paid off. Different companies will have different policies and procedures concerning this requirement. Right at the beginning, when you first purchase, the best way to avoid escrow is to put down 20% of the purchase price.