What Is an Escrow Account When Buying a Home?

Mar 24
4 min read

Updated: Apr 27

What Is an Escrow Account When Buying a Home?

An escrow account is a separate account set up and managed by your lender to pay property taxes and homeowners insurance on your behalf. Instead of paying these expenses in large annual or semi-annual bills, you contribute a portion each month through your mortgage payment. The lender then uses those funds to pay the bills when they are due.

In simple terms, escrow helps smooth out the cost of homeownership. It turns large, irregular expenses into predictable monthly payments. Many lenders require escrow when a buyer puts down less than 20%, but even when it is optional, a lot of homeowners choose it for convenience and budgeting stability.

When Do You Use an Escrow Account in Real Estate?

An escrow account can come into play at two different stages of a real estate transaction, and each serves a different purpose.

During the home buying process, escrow is used to hold the buyer’s earnest money deposit. This protects both parties while the contract is active, and those funds are released at closing based on the agreement terms.

After closing, the escrow account becomes part of the mortgage itself. At this point, the lender manages the account and uses it to pay ongoing property taxes and insurance premiums as part of your monthly housing payment.

What Costs Does an Escrow Account Cover?

Most escrow accounts are designed primarily for property taxes and homeowners insurance, but there are situations where other costs may be included. Some loans may also include flood insurance if the property is in a required zone or private mortgage insurance if applicable. In certain cases, homeowners association fees may be included, although that is less common and depends on the lender and loan structure.

How Does an Escrow Account Work Each Month?

Each month, your mortgage payment is typically divided into four components: principal, interest, taxes, and insurance. This is often referred to as PITI.

For example, a homeowner might have a $2,000 mortgage payment toward principal and interest. If property taxes are $6,000 per year, that adds about $500 per month. If homeowners insurance costs $1,200 per year, that adds another $100 per month. In this case, the total monthly payment would be $2,600, with $600 going into escrow for taxes and insurance.

The lender holds those funds and pays the tax and insurance bills when they are due.

Why Do Lenders Require Escrow Accounts?

Lenders use escrow accounts to reduce financial risk. If property taxes are not paid, the home could face a tax lien. If insurance lapses, the property is no longer protected against damage or loss, which puts both the borrower and lender at risk.

By collecting and managing escrow funds, the lender ensures that taxes and insurance remain current, protecting the property and maintaining compliance with loan requirements.

Can You Waive an Escrow Account?

In some cases, yes. Escrow may be waived if a borrower puts down 20% or more, has strong credit, and the lender allows it. However, not all lenders offer this option.

Without escrow, homeowners are responsible for paying taxes and insurance directly in full when they are due. While this gives more control over cash flow, it also requires careful budgeting since these are large, less frequent expenses.

What Is an Escrow Shortage or Surplus?

Escrow accounts are reviewed annually to ensure they are collecting the correct amount.

An escrow shortage happens when the account does not have enough funds to cover rising taxes or insurance costs. In that case, the homeowner may need to make a one-time payment or see an increase in their monthly mortgage payment.

An escrow surplus occurs when too much money has been collected. In this situation, the lender may issue a refund or reduce future payments.

How Does Escrow Impact Your Monthly Payment?

Escrow amounts are not fixed forever. They can change based on shifts in property taxes, insurance premiums, or reassessments of your home’s value.

This is why monthly mortgage payments may increase even when your interest rate and loan terms stay the same. The change is often tied directly to escrow adjustments rather than the loan itself.

Key Takeaways

Escrow accounts simplify homeownership by spreading large annual expenses into predictable monthly payments. They are commonly required for financed purchases and primarily cover property taxes and insurance. Because these costs can change over time, escrow payments may also adjust annually.

About This Guide

This escrow account guide is based on standard mortgage lending practices and real-world real estate transaction experience. Working with buyers across New Hampshire, Maine, and Northern Massachusetts, I regularly help clients understand how escrow impacts their monthly payments and overall affordability.

Clear explanations of costs like escrow are an important part of helping buyers make informed and confident decisions throughout the home buying process.

Need Help Understanding Escrow and Monthly Costs?

If you are buying a home and want a clear breakdown of your full monthly payment, including escrow, I can help you understand exactly what to expect.

Reach out to me, Hunter Letendre, REALTOR® with Berkshire Hathaway HomeServices Verani Realty, serving New Hampshire, Maine, and Northern Massachusetts. I help buyers understand the full financial picture so they can move forward confidently knowing how escrow and other costs fit into their long-term homeownership plan.