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What Is a Mortgage Escrow and How Does It Work?

A mortgage escrow breaks up property tax, homeowners insurance, and other real estate payments into monthly installments.

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By Daria Uhlig

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Daria Uhlig

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Daria Uhlig is a contributor to Credible who covers mortgage and real estate. Her work has appeared in publications like The Motley Fool, USA Today, MSN Money, CNBC, and Yahoo! Finance.

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Edited by Daria Uhlig

Written by

Daria Uhlig

Writer

Daria Uhlig is a contributor to Credible who covers mortgage and real estate. Her work has appeared in publications like The Motley Fool, USA Today, MSN Money, CNBC, and Yahoo! Finance.

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Updated December 18, 2023

Editorial disclosure: Our goal is to give you the tools and confidence you need to improve your finances.

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A mortgage loan escrow account is a dedicated account set up to hold payments toward certain mortgage- and property-related expenses. 

The account allows you to pay larger expenses, such as property tax, in monthly installments as part of your mortgage payment. It also allows your mortgage lender to pay those bills on your behalf as they come due. 

That arrangement is convenient for the homeowner because it relieves you of having to track important due dates. Lenders often require it because the escrow protects their investment in the property by ensuring that those important bills get paid.

What is an escrow on a mortgage and how does it work?

Escrow is an agreement between two parties for a third party to hold money or other assets until they’re ready to be disbursed under the conditions specified in the agreement.

In the case of an escrow on a mortgage, the two parties are the homebuyer and the mortgage lender, and the third party is a bank. The asset is money the buyer prepays toward insurance and property tax. 

Among the closing costs you pay when you close on a home purchase and mortgage loan are advance payments toward property taxes and insurance. How many months’ worth of each you prepay varies from state to state, but expect to prepay at least two months’ worth of each.

The lender will open an escrow account to hold these prepayments. It’ll also divide the total amount due in the coming year by 12 and add that amount to your mortgage payment — perhaps with a small cushion in case of a tax or insurance premium increase. 

As you make your mortgage payments each month, the lender takes the portion due for escrow and puts it into the escrow account. Then, when the property tax and insurance bills come due, the lender pays them from the escrow account.

Your escrow amount is likely to change from one year to the next based on the lender’s annual escrow analysis. If your tax or homeowners insurance rate drops, your payment will drop, too. If tax or insurance goes up, your mortgage payment will increase accordingly. 

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Types of escrow accounts

Escrow accounts are always used for prepayments. While many of those prepayments are for bills due after closing, some are credited toward the purchase itself.

  • Earnest money deposit: An earnest money deposit is the deposit you pay to the seller when they accept the offer on your home. Payment is part of what makes a contract enforceable, but in the case of a home sale, the seller is not entitled to it until closing. Your earnest money goes into an escrow account for safekeeping until closing, when it’s credited toward the purchase price.
  • Repair holdback: If you’re purchasing a home that needs repairs but the seller is unable to complete them before closing, you might request an escrow “holdback.” The holdback consists of a portion of the purchase price. The funds are released to the seller once the repairs are complete.
  • Homeowners insurance: Lenders require borrowers to have enough homeowners insurance to repair or rebuild the home if it’s damaged or destroyed by a covered emergency, such as a fire or fallen tree. Escrowing some of the premium in advance ensures that the funds will be available to pay the insurance by its due date so there’s no lapse in coverage.
  • Flood insurance: Homeowners insurance doesn’t cover floods. You need special flood insurance for that type of coverage. If your lender requires you to have flood insurance, it might also require that payments toward it be escrowed.
  • Property tax: Counties and municipalities levy property tax to fund schools and local government operations. Failure to pay property tax can result in the taxing jurisdiction placing a lien on the property. A lien jeopardizes your and your lender’s ownership stake in the property and can lead to a tax sale that eventually results in foreclosure. The property tax escrow reduces this risk.
  • Mortgage insurance: Your lender will require that you pay private mortgage insurance if you purchase your house with less than 20% down. The insurance protects the lender in the event you default on your loan. The mortgage insurance premium is typically escrowed, similar to homeowners insurance, to ensure that it gets paid.
  • Homeowners association: Homeowners in planned communities governed by a homeowners association pay dues that pay for the community’s operations and amenities. A homeowner’s failure to pay the fee can result in the HOA placing a lien on the property and ultimately taking possession of it, so some lenders allow borrowers in HOA to escrow their assessments.

Pros and cons of escrow accounts

The escrow account exists primarily for your lender’s benefit, but it provides benefits to you, too. However, there are also some drawbacks to consider.

Pros

  • Escrow accounts safeguard your earnest money deposit.
  • The monthly payments for taxes and insurance are more budget-friendly than large, less-frequent payments.
  • The lender manages the account and pays the bills on time.

Cons

  • You might pay fees for the escrow account opening and management.
  • Your mortgage payments include taxes and insurance, so getting behind in your mortgage payments could also leave you delinquent on your taxes and insurance.
  • Prepaying mortgage and interest reduces cash reserves you could put toward another use.

How to set up an escrow account

Fortunately for homebuyers, your broker or the seller’s broker places your earnest money in an escrow account and releases the funds to the seller at closing. You don’t have to open an account yourself or make a deposit.

The lender sets up the mortgage escrow account for taxes, insurance, and any other mortgage-related payments. Nothing is required on your part for that, either. 

What’s more, the lender manages the account. All you need to do is review your statements to verify that your taxes and insurance are being paid and read through the annual analysis the lender prepares so you won’t be caught off guard if your escrow payments increase.

How long do you pay escrow?

You can ask the lender to remove the escrow account at any time, but depending on the type of loan you have and the lender’s requirements, it might not be possible. However, escrow payments end after the mortgage is paid off. You’ll submit tax and insurance payments yourself after that.

Escrow on a mortgage FAQ 

Can you get escrow money back?

If the escrow balance has a surplus at the end of the year — because your taxes or insurance rate went down, or you no longer have to pay mortgage insurance, for example — you can have the excess amount refunded. The lender will also refund your escrow money once your loan is paid off.

Can I remove escrow from my mortgage?

Yes, but only if your loan and lender allow it. Escrow payments automatically end once you repay your loan in full.

What happens to the money you put in escrow?

Your lender uses the money you put in escrow to pay insurance and property taxes on your behalf. 

Is escrow money my money?

Yes. However, it’s money you’ve agreed to allow a third party to hold and your lender to disburse, so you can’t access funds in the account.

What does an escrow account not cover?

An escrow account does not cover your mortgage principal and interest payments. In most cases, it also doesn’t cover HOA fees. 

Meet the expert:
Daria Uhlig

Daria Uhlig is a contributor to Credible who covers mortgage and real estate. Her work has appeared in publications like The Motley Fool, USA Today, MSN Money, CNBC, and Yahoo! Finance.

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