When you buy a home, your monthly mortgage payment may include more than just principal and interest.
You may also be paying money toward property taxes and homeowners insurance through an escrow account.
Mortgage escrow can make paying these large annual bills easier because a portion of the expected costs is collected with your regular mortgage payment and held in the account until the bills are due.
But how does mortgage escrow actually work?
Understanding your escrow account can help you understand your total monthly mortgage payment and why that payment can sometimes change from year to year.
What Is a Mortgage Escrow Account?
A mortgage escrow account is an account used to hold money for certain property-related expenses, most commonly property taxes and homeowners insurance.
Instead of paying a large property tax or insurance bill all at once, you may contribute a portion of those expenses each month as part of your mortgage payment.
Your mortgage servicer then uses the money in the escrow account to pay the applicable bills when they come due.
For example, if your annual property taxes and homeowners insurance total $6,000, your monthly escrow contribution could be approximately $500 before accounting for other adjustments or required reserves.
This allows the cost to be spread across your monthly payments rather than requiring you to come up with the entire amount at once.
What Does Mortgage Escrow Pay For?
Escrow is most commonly used for expenses associated with owning the property.
These can include:
- Property taxes
- Homeowners insurance
- Flood insurance, when applicable
- Other insurance or property-related expenses required under the loan
The exact expenses paid through escrow depend on your mortgage and the requirements associated with your property.
When you receive your mortgage documents, review the escrow section so you understand which expenses are being collected through your monthly payment.
How Does Mortgage Escrow Work?
The basic process is fairly simple.
Your mortgage servicer estimates how much money will be needed for your property taxes and insurance.
A portion of that amount is then included in your monthly mortgage payment.
The money is deposited into your escrow account.
When your property tax or insurance bill becomes due, the servicer uses the funds in the account to make the payment.
This process repeats throughout the year.
The goal is to have enough money available in the escrow account when the bills are due.
How Is Your Monthly Escrow Payment Calculated?
Your escrow payment is generally based on the expected annual cost of the bills that will be paid through the account.
For example, suppose your estimated annual expenses are:
Property taxes: $4,800
Homeowners insurance: $1,200
Total annual escrow expenses: $6,000
Dividing $6,000 by 12 months gives an estimated monthly escrow contribution of $500.
However, your actual escrow payment may be different because the servicer may also account for changes in taxes, insurance premiums, and the required escrow cushion.
This is why your escrow portion is not necessarily a fixed amount for the entire life of your mortgage.
Why Can Your Mortgage Payment Increase?
One of the most common reasons a mortgage payment increases is a change in the amount required for escrow.
For example, your property taxes may increase after the county reassesses your home.
Your homeowners insurance premium may also increase.
If your servicer determines that more money will be needed to cover these bills, your monthly escrow contribution may increase.
Your total mortgage payment can therefore change even if your mortgage interest rate remains exactly the same.
This is an important distinction for homeowners to understand.
A payment increase does not always mean your mortgage interest rate changed.
What Is an Escrow Analysis?
Mortgage servicers generally review escrow accounts periodically to determine whether enough money is being collected to cover upcoming expenses.
This review is commonly referred to as an escrow analysis.
The servicer looks at the expected property tax and insurance bills and compares them with the money currently being collected and held in the account.
The analysis can result in:
- A higher monthly escrow payment
- A lower monthly escrow payment
- A shortage that needs to be repaid
- An escrow surplus
- No significant change
If your escrow payment changes, your servicer should provide information explaining the adjustment.
What Is an Escrow Shortage?
An escrow shortage occurs when there is not enough money in the escrow account to cover the required expenses.
For example, suppose your property taxes increased more than expected during the year.
The amount collected through your monthly payments may not have been enough to cover the larger bill.
The servicer may then determine that your account has a shortage.
Depending on the circumstances, you may be given options for addressing the shortage.
These can include paying the shortage separately or having the amount spread across future monthly payments.
The exact options depend on the applicable servicing rules and your mortgage.
What Is an Escrow Surplus?
An escrow surplus occurs when the account contains more money than is needed based on the servicer’s analysis.
If your property taxes or insurance costs turn out to be lower than expected, your account may accumulate more money than necessary.
Depending on the amount and applicable rules, the servicer may return the surplus to you or apply it according to the requirements governing your escrow account.
If you receive an escrow surplus, review the statement from your mortgage servicer so you understand why the amount occurred.
Does Escrow Include Your Mortgage Principal and Interest?
No.
Your mortgage principal and interest are separate from the escrow portion of your payment.
A typical monthly mortgage payment can include several components:
- Principal
- Interest
- Property taxes
- Homeowners insurance
- Mortgage insurance, when applicable
- HOA dues or other applicable expenses
Principal and interest are used to repay the mortgage itself.
Escrow funds are collected to pay certain property-related expenses.
Understanding these components can make it easier to see why your total monthly payment may be different from the principal and interest amount shown on your loan documents.
Is Escrow Required on Every Mortgage?
No.
Whether an escrow account is required depends on factors such as the loan type, lender requirements, down payment, property characteristics, and applicable rules.
Some mortgage programs may require escrow for certain expenses.
Other borrowers may have the option to manage their property taxes and insurance payments independently.
If you are buying a home and prefer to pay your property taxes and insurance yourself, ask your lender whether an escrow waiver or alternative arrangement is available for your specific loan.
Do not assume that every mortgage offers the same options.
Can You Waive a Mortgage Escrow Account?
In some situations, a borrower may be allowed to waive escrow and pay property taxes and insurance directly.
However, this is not available for every loan or borrower.
Lenders may have specific requirements for allowing an escrow waiver, including requirements related to the loan-to-value ratio, property type, loan program, and borrower qualifications.
Even if escrow is not required, you still need to budget for property taxes and homeowners insurance.
You would simply be responsible for making those payments directly when they are due.
What Are the Benefits of Having an Escrow Account?
Escrow can make homeownership expenses easier to manage.
Smaller Monthly Contributions
Instead of paying a large annual property tax bill all at once, you can spread the expected cost across your monthly mortgage payments.
Less Risk of Missing a Tax or Insurance Payment
Your mortgage servicer handles the applicable payments from the escrow account.
This can reduce the chance of forgetting an important bill.
Easier Budgeting
Adding property taxes and insurance to your monthly mortgage payment can make it easier to estimate your total monthly housing expense.
Protection for the Lender and Borrower
Keeping property taxes and required insurance current helps protect the property and reduces the risk of certain payment problems.
What Are the Disadvantages of Escrow?
Escrow can be convenient, but it also means your monthly payment can change when taxes or insurance costs change.
Some homeowners also prefer having direct control over their money rather than having the funds held in an escrow account.
Another consideration is that an escrow shortage can result in a higher monthly payment if the servicer needs to collect additional funds.
For many homeowners, however, the convenience of spreading these expenses across the year can outweigh these concerns.
Does Escrow Pay for Homeowners Insurance?
It can.
If homeowners insurance is included in your escrow account, a portion of your monthly mortgage payment is collected for the expected annual premium.
When the insurance bill becomes due, the mortgage servicer uses the escrow funds to make the payment.
However, homeowners should still monitor their insurance coverage and premiums.
If your insurance company changes your policy or premium, your mortgage servicer may need to adjust the escrow amount accordingly.
Does Escrow Pay Property Taxes?
It can.
Property taxes are one of the most common expenses paid through mortgage escrow.
The servicer collects money throughout the year and then uses the escrow funds to pay the tax bill when it becomes due.
Because property taxes can change, the amount you contribute toward escrow can also change.
This is one of the main reasons homeowners may see their total mortgage payment increase or decrease over time.
Can Escrow Affect Your Monthly Budget?
Yes.
When calculating how much home you can afford, it is important to look at your complete monthly housing payment rather than only the principal and interest.
Property taxes and homeowners insurance can add a significant amount to your monthly cost.
Other expenses may also apply, such as:
- Mortgage insurance
- HOA dues
- Maintenance
- Utilities
- Home repairs
Colorado property taxes and insurance costs can vary significantly depending on the property and location.
That is why your mortgage affordability should be based on the complete housing expense rather than simply the advertised principal and interest payment.
What Happens to Escrow When You Sell Your Home?
When you pay off your mortgage as part of a home sale, the escrow account associated with that mortgage is generally closed as part of the payoff process.
If money remains in the escrow account after the required expenses have been paid, the servicer generally handles the remaining balance according to applicable requirements.
The timing of any escrow refund can vary.
If you are selling your current home and buying another one, remember that your new mortgage may have a completely different escrow calculation based on the new property’s taxes and insurance.
What Happens to Escrow When You Refinance?
When you refinance, your existing mortgage is generally paid off with the new mortgage.
This can result in the old escrow account being closed.
Depending on the circumstances, you may receive a refund of eligible remaining escrow funds from the old loan.
The new mortgage may also establish a new escrow account and require an initial deposit.
This means refinancing can temporarily involve escrow-related cash flow considerations that borrowers should understand before closing.
How Can You Prepare for Escrow Changes?
You cannot always predict exactly how property taxes or insurance premiums will change, but you can prepare for the possibility.
Consider keeping some additional money available for unexpected housing expenses.
You should also review your annual escrow statement when it arrives.
Pay attention to:
- Current property tax amounts
- Insurance premiums
- Escrow balance
- Escrow shortage or surplus
- New monthly payment
- Expected future expenses
If something does not look right, contact your mortgage servicer and ask for an explanation.
What Should You Do If Your Escrow Payment Seems Wrong?
If your mortgage payment suddenly changes and you do not understand why, review your most recent escrow analysis or mortgage statement.
Look for changes in:
- Property taxes
- Insurance premiums
- Escrow balance
- Escrow shortage
- Required monthly contribution
If you still cannot determine the reason for the change, contact your mortgage servicer.
Your mortgage professional may also be able to help you understand the general structure of your payment, although the servicer is responsible for administering your specific escrow account.
How Colorado Lending Team Can Help
Understanding your total monthly mortgage payment is an important part of choosing the right home loan.
Colorado Lending Team helps Colorado homebuyers compare mortgage options and understand how factors such as interest rates, down payments, property taxes, insurance, and loan programs can affect affordability. The team provides multiple mortgage options and personalized guidance from pre-approval through closing.
If you are buying a home and want to understand what your expected monthly payment could look like, Colorado Lending Team also provides a mortgage calculator that allows borrowers to consider principal, interest, PMI, taxes, insurance, and HOA dues.
Conclusion
A mortgage escrow account is designed to help homeowners manage important property-related expenses such as property taxes and homeowners insurance.
Instead of paying those bills in large amounts when they are due, you can contribute toward them through your monthly mortgage payment.
However, escrow is not necessarily a fixed amount.
Changes in property taxes, homeowners insurance, or the balance of your escrow account can cause your monthly mortgage payment to increase or decrease.
Understanding how escrow works can help you budget more accurately and avoid surprises when your mortgage payment changes.
If you are preparing to buy a home in Colorado, ask your mortgage professional to explain the complete monthly payment, including principal, interest, taxes, insurance, mortgage insurance, and any other applicable costs.
