What the account is
The Consumer Financial Protection Bureau (CFPB) defines an escrow account, called an impound account in some states, as an account set up by your mortgage lender to pay certain property-related expenses, such as property taxes and homeowners insurance. The money that goes into it comes from a portion of your monthly mortgage payment, so a yearly tax bill and a yearly insurance premium are paid in twelve instalments instead of one or two large ones. The servicer manages the account and pays the bills from it. Many lenders require escrow; the CFPB adds that sometimes it is required by law.
Escrow is the T and the I in the PITI payment: principal and interest go to the loan, taxes and insurance go to the account. The mortgage calculator shows the full payment with those two lines included, and the home affordability calculator uses the same full figure when it works out what a lender will approve.
The rules: cushion, analysis, statement
Regulation X, the rules under the Real Estate Settlement Procedures Act, governs how a servicer runs the account:
- The cushion. A servicer may keep a reserve in the account to cover timing differences, but the cushion may be no greater than one-sixth of the estimated total annual payments from the account, which is two months of escrow deposits.
- The annual analysis. The servicer must conduct an escrow account analysis at the completion of the escrow account computation year, projecting the coming year's bills and setting the monthly deposit.
- The annual statement. Within 30 days after the end of the computation year, the servicer must send an annual escrow account statement showing what came in, what was paid out and the new payment.
One account, worked out
A home with $4,800 a year of property tax and a $1,800 homeowners insurance premium:
| Item | Amount | How |
|---|---|---|
| Yearly escrow disbursements | $6,600 | $4,800 + $1,800 |
| Monthly escrow deposit | $550 | $6,600 ÷ 12, added to the loan payment |
| Maximum cushion | $1,100 | $6,600 ÷ 6, two months of deposits |
| Initial deposit at closing | enough to pay the bills due before the monthly deposits have built up, plus the cushion | shown as section G of the Closing Disclosure |
If the next year's tax bill rises to $5,400, the analysis raises the monthly deposit by $50, and if the higher bill was already paid from the account before the deposits caught up, the difference is a shortage, collected on top. That is why an escrowed mortgage payment changes from year to year even on a fixed-rate loan: the loan payment is fixed, the escrow part is not.
Shortages, surpluses and deficiencies
| Finding of the annual analysis | What Regulation X allows |
|---|---|
| Surplus of $50 or more | must be refunded to you |
| Surplus under $50 | refunded or credited against the coming year's payments |
| Shortage of less than one month's escrow payment | may be left in place, collected within 30 days, or spread in equal monthly payments over at least 12 months |
| Shortage of one month's payment or more | may be left in place or spread in equal monthly payments over at least 12 months |
| Deficiency (the account went negative) | additional monthly deposits; under one month's payment also within 30 days, otherwise over two or more months |
A shortage is the account running lower than the cushion requires; a deficiency is the account having actually gone below zero because a bill exceeded the balance. The annual statement names which one applies and how the servicer proposes to collect it, and the 12-month spread is the borrower's protection against a sudden jump.
When the payment changes
- A new tax assessment or a rate change raises or lowers the tax bill, and the next analysis moves the deposit to match.
- An insurance premium increase, or a switch of insurer mid-year, does the same; the servicer pays whatever premium is billed.
- The first year after buying often brings the largest change, because the initial deposit was based on the seller's assessment or an estimate, and the first full bill in your name can differ.
- After PMI ends, if it was collected through the same account, the deposit falls; the guide what is PMI covers when that happens. A refinance resets the account entirely, and the refinance calculator compares the loan side; the escrow side carries over as a refund of the old account and a new initial deposit.
This guide describes the federal rules in Regulation X and the CFPB's description of escrow accounts. State law can add requirements, and the servicer's annual statement is the document that governs a particular account.
Frequently asked questions
What is an escrow account on a mortgage?
The CFPB describes it as an account set up by your mortgage lender to pay certain property-related expenses, property taxes and homeowners insurance above all. A portion of your monthly mortgage payment goes into it, and the servicer pays the tax and insurance bills from it when they fall due. Many lenders require one, and in some cases the law does.
Why did my escrow payment go up?
Because the bills it pays went up. Once a year the servicer analyses the account, as Regulation X requires, and sets next year's monthly deposit from the expected tax and insurance bills plus the permitted cushion. If last year's bills were higher than the deposits assumed, the account has a shortage, which the servicer may collect over at least 12 months, or within 30 days if it is less than one month's escrow payment. A higher property tax assessment or an insurance premium increase shows up in the mortgage payment this way.
What is an escrow cushion?
A reserve the servicer may keep in the account so that a bill arriving before the deposits have built up can still be paid. Regulation X limits it to no greater than one-sixth of the estimated total annual payments from the account, which is two months of escrow deposits. On $6,600 of yearly taxes and insurance the maximum cushion is $1,100.
What happens to extra money in my escrow account?
Regulation X says that if the annual analysis finds a surplus of $50 or more, the servicer must refund it to you; a smaller surplus may be refunded or credited against the coming year's payments. The annual escrow statement, due within 30 days of the end of the account year, shows the figure.
Can I pay taxes and insurance myself instead?
Only if the lender does not require escrow. The CFPB notes that many lenders require it and that it is sometimes required by law; where it is optional, the lender decides the terms. Without escrow you pay the same bills yourself, in one or two large payments a year instead of twelve small ones, and the mortgage calculator shows the payment both ways.
Sources
- CFPB: What is an escrow or impound account? (an account set up by the lender to pay property-related expenses such as taxes and insurance; funded from a portion of the monthly payment; often required by lenders and sometimes by law)
- Regulation X, 12 CFR 1024.17: escrow accounts (the cushion no greater than one-sixth of estimated annual payments; the annual escrow account analysis and the annual statement within 30 days; surpluses of $50 or more refunded; shortages collected within 30 days or over at least 12 months; deficiencies)
General information based on the sources above, not tax, legal or financial advice.