An escrow account is used to collect and hold funds to pay your property taxes, homeowner’s insurance and possibly other charges when they become due. The account is usually established for you by your mortgage company.
Your property taxes and homeowner's insurance expenses are included as part of your monthly mortgage payment and placed in your escrow account. The money accumulates until it's time for the mortgage company to pay your property taxes and insurance premium.
Benefits of an Escrow Account
An escrow account helps you:
- Manage your budget: You do not have to make lump sum payments when your taxes and insurance are due because you have made monthly payments throughout the year to cover those expenses.
- Gain peace of mind: You don’t need to worry about when your tax and insurance bills are due. The payments will be made, on time, on your behalf.
- Ensure that your home is protected: Your insurance coverage and tax payments will not lapse, which helps protect your investment in your home. Most mortgage companies require an escrow account for mortgages with less than a 20 percent down payment.
How an Escrow Account Works
Your monthly mortgage payment includes an amount for property taxes and insurance in addition to the amount you owe for principal and interest. Your mortgage company places the amount for taxes and insurance into an escrow account. These funds can be used only to pay taxes and insurance on your behalf.
Your mortgage company pays your property taxes and insurance bills for you when they are due. Each year, your mortgage company sends you a statement showing the prior year's escrow account activity --- amounts collected from you and payments made on your behalf. The statement also shows adjustments that may be needed based on changes in your tax and insurance costs.
Here is an example of how escrow payments are calculated:
- Annual real estate taxes: $1,800 ÷ 12 months = $150 per month
- Annual property insurance: $720 ÷ 12 months = $60 per month
- Total monthly taxes and insurance: $210
In this example, $210 would be added to your total monthly mortgage payment and applied to your escrow account. You might hear your total monthly mortgage payment referred to as your “PITI” — for principal, interest, taxes and insurance.