Escrow Accounts Explained
Why your monthly payment is higher than just Principal and Interest, and how the bank manages your taxes.
When you get a mortgage, your monthly payment consists of four parts, commonly known as PITI:
- Principal — paying down the loan balance
- Interest — interest paid based on the interest rate
- Taxes — property taxes
- Insurance — homeowners hazard insurance
The Principal and Interest go to the lender. The Taxes and Insurance are deposited into an Escrow Account.
What is an Escrow Account?
Think of it as a forced savings account managed by the loan servicer.
The lender takes your annual tax and insurance bills, divides them by 12, and adds that amount to your monthly mortgage payment.
The lender holds that money in the escrow account and pays the bills directly to the county and insurance company on your behalf when they are due.
The Annual Escrow Analysis
Because property taxes and insurance premiums fluctuate every year, your escrow payment is never fixed permanently.
Once a year, the lender performs an "Escrow Analysis." If property taxes went up, the account will be short. The lender will send you a notice that your monthly mortgage payment is increasing to cover the new higher taxes, and they may ask for a lump sum to cover the shortage from the previous year.
If taxes went down (rare, but it happens), the lender will lower your monthly payment and mail you a refund check for the overage.
Can I avoid having an escrow account?
If you put down 20% or more on a Conventional loan, you can "waive escrow." This means you only pay Principal and Interest to the lender, and you are personally responsible for writing the checks for taxes and insurance twice a year.
FHA, VA, and USDA loans, as well as Conventional loans with less than 20% down, strictly require an escrow account with no exceptions.