What Is an Escrow Account and How Does It Work?
Last updated: October 2026 · Editorial standards
When you have a mortgage, you’ve probably heard the term «escrow» — but it’s used in two different ways in the home buying process, and understanding both will prevent surprises.
Two Types of Escrow in Real Estate
1. Escrow at closing: When you make an offer and it’s accepted, your earnest money deposit goes into an escrow account held by a neutral third party (title company or escrow agent) until closing. This protects both buyer and seller during the transaction.
2. Mortgage escrow account: An ongoing account your lender manages to collect and pay your property taxes and homeowners insurance. This is what most people mean when they talk about escrow after buying a home.
This article focuses on the mortgage escrow account.
What Is a Mortgage Escrow Account?
A mortgage escrow account is a special account your lender controls. Each month, along with your principal and interest payment, you pay a portion of your estimated annual property taxes and homeowners insurance into the escrow account.
When those bills come due — typically annually or semi-annually for taxes, annually for insurance — your lender pays them directly from the escrow account on your behalf.
Why Lenders Require Escrow
Lenders require escrow accounts because:
- Property taxes: If you don’t pay property taxes, the government can place a tax lien on the home — which takes priority over the mortgage. The lender’s collateral is at risk.
- Homeowners insurance: If the home burns down and you have no insurance, the lender loses its security. Escrow ensures coverage stays in place.
Most conventional loans require escrow if your down payment is less than 20%. FHA and VA loans almost always require escrow regardless of down payment.
How Your Monthly Escrow Payment Is Calculated
Your lender estimates your annual property taxes and homeowners insurance, divides by 12, and adds that amount to your monthly payment.
Example:
- Annual property taxes: $4,800
- Annual homeowners insurance: $1,200
- Total annual escrow: $6,000
- Monthly escrow payment: $500
Your total monthly payment (PITI) = Principal + Interest + $500 escrow.
Lenders also typically require a 2-month cushion in the account — so you’ll need to fund the cushion at closing (usually included in closing costs).
Annual Escrow Analysis
Each year, your lender performs an escrow analysis to check whether your account is funded correctly. If your taxes or insurance increased, your escrow payment goes up. If they decreased, it goes down.
If there’s a shortage (the account didn’t have enough), you’ll receive a bill for the difference — or your monthly payment increases to cover it over the next year.
If there’s a surplus (the account had too much — more than the 2-month cushion), you’ll receive a refund check.
Can You Opt Out of Escrow?
If your down payment is 20% or more and your loan is conventional, you may be able to waive escrow. Some lenders charge a fee (called a waiver fee) for this — typically 0.125–0.25% of the loan amount.
Without escrow, you’re responsible for paying your own property taxes and insurance on time. Many homeowners prefer the convenience of escrow even when it’s optional.
What Escrow Does Not Cover
Your escrow account covers property taxes and homeowners insurance — it does not cover:
- HOA dues
- Utility bills
- Private mortgage insurance (PMI is usually added to your payment separately)
- Special assessments
Key Takeaways
Escrow accounts simplify homeownership by ensuring property taxes and insurance are always paid. Your lender manages the account, adjusts your monthly payment annually, and sends you a refund if there’s a surplus. If you receive an escrow analysis showing a shortage, budget for either a lump-sum payment or a higher monthly payment.
Frequently Asked Questions
Does my escrow payment ever change? Yes. Your escrow payment adjusts annually based on changes to your property tax assessment and insurance premium.
What happens if I pay off my mortgage? Once the mortgage is paid off, the escrow account closes and any remaining balance is refunded to you. You then pay taxes and insurance directly.
Can I pay my property taxes directly even if I have escrow? No. If your mortgage requires escrow, the lender pays those bills. You cannot double-pay by paying them yourself.
Why did I get a big escrow bill after the first year? Your first-year escrow payment was based on the previous owner’s tax bill. If your property was reassessed after purchase, taxes may have jumped significantly, causing a shortage.
