Mortgages are typically made up of four parts: principal, interest, taxes, and insurance. Together, these comprise so-called PITI and make up your total monthly mortgage payment.
Since taxes and insurance are typically paid annually or semiannually, they are usually held in escrow by the lender or another company servicing the loan. You pay into your escrow balance each month with your regular payment, and your taxes and insurance are automatically paid from that account when they’re due.
Key Takeaways
- Escrow is when money is held by a trusted third party pending the completion of a deal or transaction.
- Mortgage payments usually include some portion held in escrow for property taxes and insurance.
- Many lenders require escrow accounts to protect their investment and ensure that taxes and insurance are paid.
- You can’t access the money in your escrow account, and banks generally don’t pay interest on your escrow balance.
- The escrow company will periodically do an escrow analysis, which may cause your monthly payment to change.
What Is an Escrow Balance?
If your mortgage is escrowed, then your monthly payment is split into three parts. Two parts go toward principal and interest, according to your loan’s amortization schedule. Initially, most of your monthly payment covers interest. Over time, more will go toward your principal.
The third part of your payment goes toward your escrow balance. In many mortgages, funds are held in escrow to pay property taxes and homeowners insurance. When your taxes or insurance is due, the company servicing the loan will take the money out of your escrow balance to pay those bills.
Since your mortgage escrow is based on taxes and insurance premiums, it’s likely that these costs will increase over time. If your monthly escrow payments are unable to cover the difference, you may experience an escrow shortfall. In this case, your mortgage servicer will automatically adjust the monthly payment accordingly. You would then receive a notice indicating a larger monthly mortgage payment that will remain in effect until at least the next review of the escrow account.
Not All Mortgages Require an Escrow Account
Not all banks require you to escrow money for taxes and insurance. Federal Housing Administration (FHA) loans require an escrow account. This protects the bank’s investment in your property by making sure that the taxes and insurance get paid.
You can escrow your taxes and insurance even if your lender doesn’t require it. This may simplify budgeting for these expenses.
Can I Access Money in My Escrow Balance?
Typically, you cannot access the money in your escrow balance—that money is held by the lender or loan servicing company on your behalf. In most cases, the bank doesn’t pay interest on your escrow balance. The total held in your escrow account is generally included in your monthly mortgage statement or your online account information.
Periodic Escrow Analysis
The U.S. government requires lenders to regularly analyze the amount of money in your escrow account. While most lenders do this annually, they may analyze your account more often if the amount that you owe for taxes and insurance changes.
During escrow analysis, the lender calculates the amounts that will come due for property taxes and homeowners insurance in the coming year. As an example, say the upcoming year looks like this:
- January—$2,500 in semiannual property taxes
- April—$1,000 for hazard insurance
- July—$2,500 for the second half of property taxes
With $6,000 in expected yearly outlays coming up, the lender will divide that by 12 to get a $500 monthly payment toward your escrow account. Government regulations also allow escrow companies to maintain an extra amount in your account as a cushion in case unexpected payments arise. So, depending on your escrow balance, your monthly payment may be slightly more than the total expenses divided by 12.
When your lender performs their escrow analysis, they will send you a statement, either by mail or in your online account. This statement will detail the results of the escrow analysis and your new monthly payment amount.
What Is in My Escrow Balance?
Your mortgage escrow balance will typically include money set aside for paying property & school taxes along with home and mortgage insurance premiums. Your mortgage servicer pays these obligations out of your escrow account on your behalf, and reviews the amounts paid periodically to minimize the chances of a shortfall.
What Is the Difference Between the Escrow Balance and the Principal Balance?
The escrow balance for a mortgage refers only to that money set aside to pay for obligations like taxes and insurance that are paid on your behalf by your mortgage servicer. The principal balance refers instead to the amount of the home loan that is still outstanding. Thus, with every mortgage payment, your principal balance will decrease a little but your escrow balance may grow as it accumulates until your property taxes are due.
What Happens to the Escrow Balance if You Pay Off Your Mortgage?
If you pay off your mortgage early or it ultimately runs its entire course, your escrow balance will be refunded back to you and your mortgage agreement will cease. It can take up to one month to receive this refund. When your mortgage is paid off, you will become responsible for paying your property taxes and insurance premiums yourself.
Do Escrow Balances Earn Interest?
There is no federal mandate that escrow balances be held in an interest-bearing account, and so many do not earn interest. Some states have their own laws that do require interest to be paid on these amounts, including: Alaska, California, Connecticut, Iowa, Maine, Maryland, Massachusetts, Minnesota, New Hampshire, New York, Oregon, Rhode Island, Utah, Vermont, and Wisconsin.
The Bottom Line
Your escrow balance is the amount of money that is held for you in your escrow account (also called an impound account in some areas of the country). You pay into your escrow account each month as part of your regular mortgage payment. Not all lenders require an escrow account, though many do. Even if your lender doesn’t require it, many people prefer having an escrow account since it makes budgeting for these expenses easier.