What Is Mortgage Escrow?

By Sari R. Updated on 7/21/2017

Mortgage escrow accounts let borrowers build up money for homeowners’ policy premiums and property taxes gradually.  Escrow accounts are suggested for first time home buyers because buyers will be able to avoid surprises such as missed payments. Lenders often require borrowers with less than 20% down to have an escrow account.

How Does Escrow Work?

Escrow operates in a similar fashion to a savings account. The difference, however, is that customers must deposit pre-arranged amounts monthly. These monthly payments build up at the bank, and the borrower’s lender is then liable for paying the borrower’s insurance premiums and property taxes. Escrow accounts are kept open until the borrower can pay the mortgage down to the eighty percent loan-to-value amount. 

Why Is Escrow Helpful?

Having an escrow account is a great way for first-time home buyers to budget.  It ensures that you'll always have your mortgage payment on hand.  This is especially useful since it’s often hard to know how much payment for taxes and insurance will be. 

Why Does Escrow Need to be Recalculated?

Every year, lenders will run an analysis program to determine if the monthly amounts paid were enough to cover the insurance and tax bills.  Typically, lenders prefer that borrowers keep a month or two of extra payments in the account as a back-up because rate changes or tax assessment adjustments can change at any point during the year.  When this happens, lenders often have to pay the shortcomings out of pocket.

Will My Payments be Adjusted?

Payments tend to be adjusted year after year. This could be due to a number of factors, such as a new home’s construction being completed or a change in various interest rates. New-construction home buyers need to be aware of the fact that many lenders calculate escrow based on the last disbursement. 

So, if a borrower is building a house, the first calculation for payment will be based on land alone. However, after the house is complete, the next calculation will be based on the house and land. This leads to unexpected shortages in the escrow account which will be covered by the lender but then billed to the borrowers.

What Precautions Should I Take?

First-time home buyers should make sure to watch their escrow accounts. This holds true especially after a loan transfer has occurred.  In all the confusion associated with loan transfers, sometimes both the old party and new party end up skipping paying the new taxes and insurance. This isn’t good because it can end up negatively affecting the first time home buyer’s bill.

Borrowers should be especially proactive in monitoring their escrow accounts when refinancing. In the case of a refinance, the escrow account is usually closed by the original lender. This can either lower the amount due at the closing of the refinance or the lender will send the borrower the difference in a check. However, this process is usually very long (especially with larger lenders) and third party tax processing involvement can result in rebates being delayed. 

Refinancing home owners should therefore not necessarily depend on escrow tax reimbursements to cover closing costs.