Figuring out how escrow works

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Ask a Lender
September 1, 2016 | Updated September 15, 2017


Key Points

How escrow works

  • Escrow accounts are often required, either by lenders or by state law.
  • Property taxes and homeowners insurance are paid out of escrow.
  • The money for those bills is split into monthly installments and added to your mortgage payment.
  • If escrow isn't mandated, it often can be requested by the borrower.

Property-tax and homeowners insurance bills typically come once or twice per year and can be hefty. They also are vitally important to pay on time.

If property taxes aren't paid on time, you could face governmental fines or the possibility of foreclosure. If insurance fees aren't paid, a lender can take action including purchasing new, more expensive insurance that only protects the lender — not the homeowner.

When it comes to paying these bills on time, escrow can play a vital role.

Whenever required, either by your lender or by your state's laws, a lender will set up an escrow account to help take care of those large payments. When escrow is part of a mortgage, the annual cost for property taxes and homeowners insurance (and, occasionally, other necessary expenses) will be split into monthly payments, which get added onto the payment for your mortgage principal and interest. Then, when tax and insurance bills are received, they are automatically paid out of the escrow account.

Escrow is designed to make life easier on borrowers, as they don't have to worry about coming up with significant amounts of money once those hefty bills come due.

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If you have a fixed-rate loan (such as the industry-standard 30-year fixed-rate mortgage), your principal and interest payments will remain consistent throughout the duration of your loan. If you have an escrow account, however, your total monthly mortgage payment may change, because the taxes and insurance premiums can fluctuate annually. Still, as long as you pay your monthly payments in full, you can ignore your tax and insurance bills when they come in the mail.

No escrow required?

Not all loans require an escrow account. In situations where there is no escrow, borrowers must pay their tax and insurance bills when they come due. But even if escrow isn't required by law, borrowers can still ask to have such an account established.

"Even if your lender does not require an escrow account, consider requesting one voluntarily," the Consumer Financial Protection Bureau (CFPB) suggests. "… That way you don't have to scramble to pay a large property tax bill or insurance premium."

When discussing home-financing options with your lender, ask if an escrow account will be required. If it isn't required, think about whether you would like to request escrow, and if not, start planning other ways to ensure you have enough funds to pay your property taxes and homeowners' insurance.

At the mortgage closing, you will also receive an Initial Escrow Disclosure. This form details your monthly payments, showing how much goes toward principal and interest, and how much goes into the escrow account to pay those other necessary fees. It also will show the future monthly balances of your escrow account, and when that account will be tapped to pay off tax and insurance bills.

The CFPB provides an example of this form on its website. If, during closing, you have any questions about this form or the monthly payments, ask your lender for clarification before signing the disclosure statement.

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