Understanding Escrow

Two Different Uses of the Word Escrow

The term escrow appears in two different contexts during home buying, which can cause confusion. Before closing, it usually refers to a neutral third party holding a deposit. After closing, it usually refers to an ongoing account that collects money for property taxes and insurance.

Escrow Before Closing

When a buyer and seller sign a purchase contract, the buyer typically submits an earnest money deposit, a sum of money showing serious intent to purchase. This money is held by a neutral party, often a title company, rather than going directly to the seller. If the sale closes, the deposit is applied toward the buyer's costs. If the sale falls through under specific contract terms, the deposit may be returned to the buyer.

Escrow After Closing

Many mortgage loans include an ongoing escrow account, sometimes called an impound account, set up at closing. Instead of paying property taxes and homeowners insurance directly and separately, the borrower pays a portion of these costs each month along with their mortgage payment. The lender or loan servicer holds these funds and pays the tax and insurance bills on the borrower's behalf when they come due.

How the Monthly Payment Is Structured

Why Escrow Amounts Change

Property taxes and insurance premiums can increase or decrease from year to year. Loan servicers periodically review escrow accounts and may adjust the monthly amount collected to make sure enough funds are available when bills come due. This can result in a payment increase, or occasionally a refund if too much was collected.

Is Escrow Always Required

Whether an ongoing escrow account is required depends on the loan program, lender, down payment size, and sometimes state law. Some borrowers may have the option to pay taxes and insurance directly instead, though this often comes with conditions.

Because escrow requirements and account rules vary by lender, loan type, and state, ask your loan servicer directly about how your specific escrow account is managed and when adjustments typically occur.

Shortages, Surpluses, and Cushions

Escrow accounts often maintain a small cushion, an extra reserve amount, to cover unexpected increases in tax or insurance bills. Regulations generally limit how large this cushion can be. If the account collects too little over the year, the servicer may require a lump-sum payment or spread the shortage over future monthly payments. If it collects too much, a refund may be issued.

Questions to Ask Your Servicer

If your escrow payment changes and the reason is unclear, ask your loan servicer for a copy of the detailed escrow analysis, which breaks down expected versus actual payments for taxes and insurance over the prior year.

Because escrow cushion limits, shortage handling, and account rules can vary by state and loan type, contact your servicer directly with questions about your specific account.