Homebuyer’s long read
Escrow accounts for property taxes and insurance
How a mortgage escrow account works, why many lenders require one, the limits federal rules place on escrow deposits, annual escrow statements, and what happens if taxes or insurance go unpaid.
For many homeowners, the monthly mortgage payment is really two payments: the loan itself, and a monthly contribution toward property taxes and insurance. That second part goes into an escrow account. Understanding it explains a lot of surprises, from a larger cash-to-close figure to a payment that changes even with a fixed rate.
What an escrow account is
The CFPB explains that an escrow account, called an impound account in some places, is set up by your mortgage lender to pay certain property-related expenses. Money goes in from part of your monthly payment, and your servicer pays bills such as property taxes and homeowners insurance on your behalf. That way, the CFPB notes, you pay small amounts each month instead of a big bill once or twice a year.
It also notes that many lenders require escrow for taxes and insurance so they can make sure the bills get paid, and that escrow accounts are sometimes required by law. For certain higher-priced mortgages, the CFPB says, you might be required to keep escrow for at least the first five years, and some loan types require it for the whole term.
Why the payment can change
Property taxes and insurance premiums can change from year to year. The CFPB explains that when they do, your escrow payment, and with it your total monthly payment, can change. A fixed interest rate keeps principal and interest the same; it does not fix taxes or insurance.
This is why your budget should treat taxes and insurance as variable costs. The payment worksheet lets you enter your own figures for each.
What you pay at closing
If you have an escrow account, the CFPB says you generally pay a certain amount into it at closing as part of your cash to close, and then a monthly amount with each payment.
For loans covered by the Real Estate Settlement Procedures Act, the CFPB describes limits on what can be required:
- At closing, the servicer can require enough to make sure the account never has a negative balance, plus a cushion of up to two months of estimated disbursements.
- Each month, it can require up to one-twelfth of the total annual escrow payments it reasonably expects to make.
The CFPB adds that for most mortgages with escrow, the servicer must provide an initial and annual escrow account statement showing account history and projected activity for the next year.
Reading the escrow lines on your forms
On the Loan Estimate, the CFPB suggests checking whether you have items in Estimated Taxes, Insurance and Assessments that are not escrowed. If so, you will pay them yourself, often in large lump sums, and you need to plan for that.
On page 2, prepaid items and the initial escrow payment at closing appear in their own sections. The CFPB reminds buyers that property taxes are set by local or state government and insurance premiums by the insurer you choose, not the lender, so check that the lender's estimates are realistic for this property.
Property tax estimates deserve a second look
Tax estimates can be based on the seller's current bill. After a sale, a property's assessed value or exemptions can change depending on local rules, and the bill may change with them. Contact your local tax assessor or collector to ask how a sale affects the assessment where you are buying, and whether you need to apply for any exemption you might qualify for, such as one for a primary residence where offered. Rules are entirely local.
If you do not have escrow
The CFPB is clear that without escrow you must plan for large bills yourself. If property taxes go unpaid, your state or local government may impose fines and penalties or place a tax lien on the home, and you could face foreclosure. If insurance lapses, your lender may buy insurance for you and bill you; the CFPB notes this lender-placed insurance is typically more expensive than a policy you buy yourself.
Even if your lender does not require escrow, the CFPB suggests considering requesting one voluntarily, because it spreads large bills into monthly amounts.
If you choose not to escrow, set up a separate savings account and move one-twelfth of your estimated annual taxes and insurance into it every month.
The annual escrow statement
Each year, read the statement for:
- what was paid out for taxes and insurance;
- the projected payments for the coming year;
- any shortage, which may increase your payment or need a lump sum;
- any surplus, and how the statement says it will be handled.
If a tax or insurance amount looks wrong, contact the servicer and the tax office or insurer. Mistakes in escrow are worth questioning.
Insurance shopping and escrow
Homeowners insurance paid through escrow is still your policy. You can compare insurers at renewal. Tell your servicer if you change insurers so payments go to the right company. See homeowners and flood insurance.
Escrow rules and requirements can change. Check the CFPB's current pages and your loan documents.
Questions to take into the next conversation
- Check whether each Loan Estimate shows taxes and insurance as escrowed.
- Ask the lender which bills will be paid from escrow and how they estimated each one.
- Check the property tax estimate against your local tax authority's records for the home.
- After closing, file the initial escrow statement and each annual statement together.
Why did my mortgage payment go up when my rate is fixed?
Usually because of escrow. The CFPB explains that property taxes and insurance premiums can change from year to year, and when they do, your escrow payment and therefore your total monthly payment can change too. Your fixed rate controls principal and interest, not taxes and insurance. Read your annual escrow statement to see what changed.