8 Important Questions About Escrow Answered
WHAT YOU'LL LEARN
What “in escrow” means during homebuying
How escrow accounts manage taxes and insurance
Why your escrow payment may change yearly
WHAT YOU'LL LEARN
What “in escrow” means during homebuying
How escrow accounts manage taxes and insurance
Why your escrow payment may change yearly
If you're buying a home, you’ll likely hear the word escrow more than once along the way. First, your real estate agent might say, “You’re officially in escrow!” after your offer is accepted. Later, your Mortgage Banker may explain that your monthly mortgage payment will include principalThe amount of money that you borrow from a lender. The interest is the cost of borrowing that money.principalThe amount of money that you borrow from a lender. The interest is the cost of borrowing that money., interestThe money, applied as a percentage, that it costs to borrow money (the principal) from a lender.interestThe money, applied as a percentage, that it costs to borrow money (the principal) from a lender. – and escrow. But what exactly does that mean?
So, let’s break down how escrow works, why it’s important, and what it covers during and after the homebuying process.
1. What Does It Mean to Be “In Escrow?”
When you're "in escrow," it means the homebuying process is moving forward, and a neutral third party – often called a closing agent or escrow agent – is now managing the transaction.
The term escrow refers to placing something in the care of someone else until certain conditions are met. In this case, that “something” is your home purchase.
Expert Tip
The escrow agent oversees important details like contracts, funds, and documents to help ensure everything goes smoothly from offer to closing day.
2. What’s an Escrow Account?
An escrow account is a special account your lender sets up to help manage certain homeownership costs – namely, your property taxes and homeowners insurance.
Instead of paying those large bills all at once, you’ll pay a portion of the total each month as part of your regular mortgage payment. When those bills come due – whether it’s quarterly, semi-annually, or annually – your loan servicer uses the funds from your escrow account to pay them on your behalf.
It’s a simple way to stay on top of your expenses without having to track due dates or set reminders.
3. How Is Escrow Calculated?
Your lender estimates the total cost of your property taxes and homeowners insurance for the year, then divides that amount into 12 monthly installments. These monthly escrow payments are added to your mortgage’s principal and interest to create one total monthly payment.
Each time you make a mortgage payment, the escrow portion is set aside in your escrow account.
When tax and insurance bills are due, your loan servicer uses the funds in that account to pay them directly (so you don’t have to worry about it).
4. What Happens If There Isn’t Enough in Your Escrow Account?
If your escrow account doesn’t have enough money when a bill is due, don’t panic. Your loan servicer will usually advance the necessary funds on your behalf to ensure your taxes and insurance are paid on time. Then, they’ll adjust your escrow balance and recover the difference through future mortgage payments.
5. Does the Escrow Payment Stay the Same Each Year?
Not always. Your escrow account is reviewed annually to make sure the right amount is being collected based on updated tax and insurance costs.
If your bills were lower than expected, you might receive a refund check for the overage. If they were higher, you’ll have a shortage. That shortage is typically divided over 12 months and added to your future mortgage payments, so your total monthly payment may increase slightly. This often happens if your property taxes or insurance premiums go up during the year.
6. Wasn’t There an Escrow Cushion Paid at Closing?
Yes, possibly! Most escrow accounts include what's called a cushion, which is typically equal to two months’ worth of escrow payments. This cushion is collected at closing and stays in your escrow account as a buffer to help cover unexpected increases in taxes or insurance.
Your loan servicer factors this cushion into your annual escrow analysis to ensure there’s always a little extra set aside.
Expert Tip
Whether or not a cushion is required depends on federal and state regulations, as well as your specific loan terms.
7. How Will I Know If My Escrow Is Changing?
You’ll usually receive copies of your updated property tax and insurance bills, which can give you a heads-up about any cost increases.
More importantly, your lender is required by law to send you an Annual Escrow Account Disclosure Statement.
This letter explains any changes to your escrow account and outlines how your new monthly mortgage payment was calculated.
You'll get this notice in advance, giving you time to plan if your payment is going up or down.
8. Can You Prevent an Escrow Shortage from Raising Your Payment?
If your escrow account ends the year with a shortage, your lender will typically give you two options:
Pay the shortage in full now, or
Spread the shortage over 12 months and have it added to your future mortgage payments.
Paying it upfront can help keep your monthly payment from increasing. While escrow accounts make budgeting for taxes and insurance easier, it’s helpful to remember those costs can change year to year. So, small payment fluctuations are normal.
A Handy Tool for Homeowners
Escrow might seem complicated at first, but it’s really just a helpful tool that simplifies homeownership.
It ensures your taxes and insurance are paid on time, keeps your payments predictable, and gives you one less thing to worry about. And if you ever have questions about your escrow account or mortgage payment, your loan servicer – or the trusted mortgage advisors here at Atlantic Bay – are just a call away.