For many homeowners, the monthly mortgage payment includes far more than principal and interest. A large share often goes into a mortgage escrow account that your loan servicer uses to pay property taxes and homeowners insurance on your behalf. When those bills rise, your payment rises too, sometimes with little warning. This guide explains how escrow works, how the annual analysis is done, and what to do if you receive a shortage notice.
What an escrow account is
An escrow account, sometimes called an impound account, is an account held by your mortgage servicer. Each month, part of your payment is deposited into it. When your property tax bill or insurance premium comes due, the servicer pays it from the account. This protects the lender’s collateral by making sure taxes are paid, preventing tax liens, and keeping the home insured.
A typical payment is often described as PITI: principal, interest, taxes, and insurance. If you have private mortgage insurance, FHA mortgage insurance, or flood insurance, those premiums are usually paid through escrow as well.
When escrow is required
Lenders commonly require escrow for loans with less than 20% down, for FHA and USDA loans, and for higher-priced mortgages as defined by federal rules. VA loans also commonly require it, in practice. Some conventional borrowers with substantial equity can request a waiver, discussed below.
How the account is set up at closing
At closing, you typically fund an initial escrow deposit. The amount depends on when tax and insurance bills are due and how many months of payments the servicer needs on hand. You will see it on your Closing Disclosure under “Initial Escrow Payment at Closing.” Many buyers also prepay the first year of homeowners insurance at closing.
The annual escrow analysis
Servicers must review escrow accounts at least once a year under the Real Estate Settlement Procedures Act (RESPA) and its implementing rule, Regulation X. In the analysis, the servicer:
- Projects the next 12 months of tax and insurance payments.
- Calculates the monthly deposit needed to pay those bills.
- Determines the lowest point the account will reach.
- Compares the projected balance with the allowable cushion.
- Identifies any surplus, shortage, or deficiency.
You receive an annual escrow account statement showing last year’s activity and next year’s projection.
The cushion
RESPA allows the servicer to keep a cushion, an extra amount to cover unexpected increases. The cushion may not exceed one-sixth of the estimated total annual disbursements, roughly two months of escrow payments, unless your loan documents or state law require less.
Surplus
If the account is projected to have more than needed, a surplus exists. If the surplus is $50 or more and you are current on your payments, the servicer must refund it within 30 days. Smaller surpluses can be refunded or credited against next year’s payments.
Shortage versus deficiency
- A shortage means the projected balance is lower than the target balance, usually because taxes or insurance went up.
- A deficiency means the account actually went negative because the servicer advanced money to pay a bill.
For a shortage of less than one month’s escrow payment, the servicer may ask you to pay it within 30 days or spread it over 12 months. For larger shortages, the servicer must allow repayment over at least 12 months if it seeks repayment. Many servicers give you the choice to pay the shortage in a lump sum to keep your monthly payment lower.
Why your payment went up
An escrow payment increase usually has two parts:
- Higher ongoing costs, such as a new property tax assessment or a higher insurance premium.
- Shortage recovery, spreading last year’s shortfall over the coming year.
Paying the shortage in full eliminates the second part but not the first. In recent years, rising homeowners insurance premiums in many states, especially those exposed to hurricanes, wildfires, and severe convective storms, have driven large escrow increases.
What you can do about rising escrow costs
Challenge your property tax assessment
Most local governments allow homeowners to appeal an assessment. Check the assessed value against recent sales of comparable homes and look for errors in square footage, lot size, or features. Apply for exemptions you qualify for, such as homestead, senior, veteran, or disability exemptions.
Shop your homeowners insurance
Compare quotes from several insurers, consider a higher deductible, and ask about discounts for bundling, roof upgrades, or protective devices. If you change insurers, notify your servicer immediately with the new declarations page so it pays the correct company and does not buy force-placed insurance, which is typically much more expensive.
Review the analysis for errors
Compare the projected bills with actual tax bills and insurance renewals. If the servicer used an outdated or incorrect figure, request a new analysis.
Errors and disputes
Under RESPA, servicers must pay taxes and insurance on time from escrow if your payment is not more than 30 days overdue. If a servicer misses a payment and you incur a penalty, contact the servicer in writing. You can send a notice of error, a written request that the servicer must acknowledge within five business days and generally resolve within 30 business days. If the problem is not fixed, file a complaint with the Consumer Financial Protection Bureau.
Waiving escrow
Some lenders allow borrowers with conventional loans and sufficient equity, often a loan-to-value ratio of 80% or less, to pay taxes and insurance directly. Lenders may charge a fee or a slightly higher rate for an escrow waiver. Without escrow, you must budget for large lump-sum bills yourself. Missing a tax payment can lead to penalties and a tax lien, and allowing insurance to lapse can trigger force-placed coverage and lender requirements to reinstate escrow.
Escrow when you pay off or refinance
When you refinance or pay off the loan, the old servicer must return any remaining escrow balance, generally within 20 business days of payoff. In a refinance, you may fund a new escrow account at closing before receiving the old refund, so plan cash flow accordingly.
A worked example
Suppose your annual property tax bill is $4,800 and your homeowners insurance premium is $1,800, for total yearly disbursements of $6,600. The monthly escrow deposit needed is $550. The maximum cushion allowed is one-sixth of $6,600, or $1,100.
Now assume your insurer raises the premium to $2,400 at renewal. Total disbursements become $7,200, and the base monthly deposit rises to $600. If the account ran short by $600 during the past year because the servicer paid the higher premium before your deposits adjusted, the servicer may spread that shortage over 12 months, adding $50 a month. Your escrow payment would rise from $550 to $650 until the shortage is recovered, then settle at about $600 if nothing else changes. Paying the $600 shortage in a lump sum would set the payment at $600 immediately.
Questions to ask your servicer
- Which tax bills and insurance policies is escrow currently paying, and on what dates?
- What figures were used to project next year’s disbursements?
- How was the cushion calculated, and what is the target low-point balance?
- Can I pay the shortage in a lump sum, and how will that change my payment?
- If I switch insurers, what documents do you need and by when?
Related reading: How a HELOC Works: Draw Periods, Variable Rates, and Smart Ways to Use Home Equity and Debt-to-Income Ratio: How Lenders Measure It and How to Improve Yours Before Applying.
Frequently Asked Questions
What does a mortgage escrow account pay?
Usually property taxes and homeowners insurance, and often mortgage insurance and flood insurance premiums.
Why did my mortgage payment go up?
Most often because property taxes or insurance premiums rose, plus repayment of any shortage identified in the annual escrow analysis.
How much cushion can a servicer keep?
No more than one-sixth of the estimated annual disbursements, about two months of escrow payments.
Can I pay my escrow shortage in a lump sum?
Usually yes. Paying it in full removes the shortage portion from your payment, though higher ongoing costs remain.
Can I get rid of my escrow account?
Some conventional borrowers with enough equity can request an escrow waiver, sometimes for a fee. Government-backed loans generally require escrow.
This article is for general informational purposes only and is not legal, medical, tax, or financial advice. Rules vary by state and change over time; confirm details with the relevant agency or a licensed professional.
