What Is a Mortgage Escrow Account?

People who own real property have to pay property taxes. If you have a mortgage loan on your home, the servicer might collect money as part of the monthly payments to later pay the property taxes, as well as certain other costs, like:

• homeowners' insurance
• private mortgage insurance (PMI), and
• homeowners' association (HOA) dues.

The loan servicer pays the costs for these items on the homeowner's behalf through an escrow account. Lenders often require borrowers to have an escrow account as a condition of getting a loan. The idea is to protect the lender from the possibility that you won't regularly pay these expenses on your own.

Here's what you should know about mortgage escrow accounts if you're planning on getting a mortgage loan.

What Is an Escrow Account in a Mortgage?

In the context of mortgages and deeds of trust, the term "escrow" means something different than it does when you buy a home. (For the purpose of this article, the terms "mortgage" and "deed of trust" are used interchangeably.)

How Does Escrow Work at Closing?

When buying a home, "escrow" refers to the situation when a neutral third party collects and disburses the required funds and documents used in the closing process.

How Does Mortgage Escrow Work?

On the other hand, with a mortgage escrow account, you pay extra amounts to the servicer along with your monthly payment of principal and interest. Borrowers typically have to pay these extra amounts to cover property taxes and homeowners' insurance. Sometimes, PMI and HOA dues are also escrowed. (For conventional mortgages, most lenders require PMI if your down payment is less than 20%.)

The servicer puts these amounts into the mortgage escrow account, sometimes called a "trust account" or a "mortgage impound account" (like in California), and pays for these items, collectively called "escrow items," on your behalf out of that account. If money for escrow items isn't collected and paid through this kind of account, the homeowner must pay the expenses directly.

Escrow accounts are usually established and initially funded at loan settlement.

How Mortgage Escrow Accounts Work

When a mortgage loan has an escrow account, the borrower has to pay an estimated portion of the escrow items each month, usually at the rate of one-twelfth of the yearly amount that's due. The Real Estate Settlement Procedures Act (RESPA) generally governs how much borrowers have to pay into an escrow account, although state law may provide greater rights to the borrower than RESPA.

Example. Say your property taxes are $5,000 per year, and homeowners' insurance costs $1,000. Your loan servicer would have to collect a minimum of $6,000 from you each year, which is $500 per month.

The servicer then pays the escrow items when they become due; the bills go directly to the servicer.

Escrow Cushion

Under federal law, the lender may also require a "cushion," that is, the borrower has to pay a bit extra each month to cover unexpected increases in the cost of escrow items. But the lender can't require more than one-sixth of the total estimated yearly escrow amount. (12 C.F.R. § 1024.17). State law might place further limits on how much the lender may collect and could require a smaller cushion.

If the costs for escrow items go up or down—like if the taxes for your home are reassessed or your homeowners' insurance company changes its rates—your escrow payment will also change.

Mortgage Escrow Account Rules Lenders Have to Follow

Every year, loan servicers have to review escrow accounts to ensure the escrow portion of borrowers' monthly mortgage payments cover the escrow item costs while also maintaining the minimum escrow account balance. This process is called an "escrow analysis." (12 U.S.C. § 2609(c)).

Be Sure to Review Your Escrow Analysis

If your mortgage loan has an escrow account, you can and should review the escrow analysis whenever the servicer completes one. Servicers usually provide this information through the mail, as well as online. Check your lender or servicer's website and log in to your account to see what escrow payments are being made out of your account.

Look for potential errors, like missed payments to the taxing authority or your homeowners' insurance company. If you notice something is amiss, or if your insurance company or tax collector informs you that your payment is delinquent, contact your loan servicer immediately.

When You Might Not Get an Escrow Analysis

However, if you're over 30 days behind in your payments when the analysis is completed, or you're in foreclosure or bankruptcy, the servicer doesn't have to send you the statement.

But if you reinstate the loan later on or otherwise bring it current, like by completing a loan modification, the servicer must provide an account history since the last annual statement within 90 days of when the account became current. (12 C.F.R. § 1024.17).

How to Lower Your Escrow Payments

Generally, you can't adjust your property tax payment amount. Though, you might be able to challenge your home's assessed value or take advantage of an abatement, deferral, or repayment program, which could lower your escrow payments.

You could also shop around for homeowner's insurance and pick the policy with the lowest price, which would, in turn, lower your escrow payments. However, picking a cheap insurance policy isn't always a good idea because it could have inferior coverage. Lenders normally specify minimum policy limits and hazards that must be covered.

Downsides to Having an Escrow Account

Servicers sometimes fail to make timely disbursements from borrowers' escrow accounts for property taxes, homeowners' insurance, or other charges. As a result, you might be on the hook to pay penalties or fees. In a worst-case scenario, you could lose your home to a tax sale (see below) if the servicer doesn't pay the taxes or you might have to deal with uninsured damage if the servicer neglects to pay the insurance premiums.

So, if you're worried about these bills getting paid, an escrow account might not be ideal. However, as noted earlier, if you have an escrow account, you can and should keep tabs on the account to ensure that the servicer pays the tax and insurance bills. That way, you'll know if any bills aren't getting paid.

Also, you'll probably miss out on earning interest on the money you send to the servicer. However, some states require loan servicers to keep borrowers' escrow money in interest-bearing accounts. Many states also have a law requiring the servicer to keep escrow funds in an insured bank account and not commingle the escrow funds with the servicer's own funds.

Benefits to Having an Escrow Account

Having an escrow account can make it easier for you to budget because you don't have to pay the taxes and insurance in large lump sums, usually in one or two payments each year. Instead, you spread out the payments over the entire year.

Also, you don't have to remember to pay the bills on your own. Forgetting to pay the bills can have serious consequences.

What Happens If You Don't Pay Your Homeowners' Insurance

If you fail to purchase homeowners' insurance, your lender might buy a "force-placed" or "lender-placed" insurance policy, and add the amounts to your loan balance. This type of insurance typically costs more and provides fewer benefits than insurance that you could buy on your own.

What Happens If You Don't Pay Your Property Taxes

If you fail to pay the property taxes, the taxing authority might charge you penalties, interest, and fines.

Also, when you don't pay the property taxes, the overdue amount becomes a lien on the property. A "lien" is a claim against your property to ensure you'll pay the debt; it effectively makes the home act as collateral for the debt. So, if you don't pay the delinquent taxes, you could lose your home to a tax sale or a foreclosure.

You could lose your home to a tax sale. All states have laws that allow the local government to sell a home through a tax sale process to collect delinquent taxes.

For example, in a tax lien certificate sale, the taxing authority sells the tax lien, and the purchaser gets the right to collect the debt along with penalties and interest. If the delinquent amounts aren't paid, the purchaser can typically foreclose or follow other procedures to convert the certificate to a deed.

In some jurisdictions, though, a sale isn't held. Instead, the taxing authority executes its lien by taking title to the home. State law then generally provides a procedure for the taxing authority to dispose of the property, usually by selling it. In other jurisdictions, the taxing authority uses a foreclosure process before holding a sale.

You could lose your home to a foreclosure. Property tax liens almost always have priority over other liens, including mortgage liens. Because a property tax lien has priority, mortgages get wiped out if you lose your home through a tax sale. So, the loan servicer will usually advance money to pay delinquent property taxes to prevent this from happening.

The servicer will then demand reimbursement from you (the borrower). The terms of most mortgage contracts require the borrower to stay current on the property taxes. If you don't reimburse the servicer for the tax amount it paid, you'll be in default under the terms of the mortgage, and the servicer can foreclose on the home in the same manner as if you had fallen behind in monthly payments.

How to Remove an Escrow Account from a Mortgage

If after considering the upsides and downsides of having this type of account, you decide you want to remove an escrow account from your mortgage loan, you might (or might not) be able to do so. Borrowers with certain kinds of loans, like FHA-insured mortgages, must have escrow accounts. And some lenders require escrow accounts. The rules for canceling escrow accounts vary, so ask your loan servicer if you qualify.

Remember, if you don't have an escrow account, you're responsible for paying the escrow items directly. If the lender cancels your escrow account but later discovers you're not paying the taxes or insurance, it will probably set up an escrow account for you at that time.

How to Get More Information About Escrow Accounts

Consider talking to a real estate attorney if you have further questions about how escrow accounts work, including the pros and cons of having one.

To learn about the different aspects of buying a home, see Nolo's Essential Guide to Buying Your First Home, by Ilona Bray, Ann O'Connell, and Marcia Stewart (Nolo).