What Is an Escrow Account? (And Should I Waive It?)

An escrow — or impound — account is a lender-held account that collects a portion of your annual property taxes and insurance each month and pays those bills when due.

The word “escrow” is used for two different things in real estate: this ongoing account, and the neutral third party holding funds during a transaction. This article covers the first.

How the mechanics work

Annual property taxes of $4,800 and insurance of $1,600 total $6,400. Divided by twelve, that is roughly $533 added to your monthly payment. The lender holds it and pays the bills as they arrive.

Two reasons lenders want this: an unpaid property tax bill creates a lien with priority over the mortgage, and a lapsed insurance policy leaves the collateral unprotected. Neither is acceptable to a lender, so they take control of both.

The cushion, and what RESPA allows

Lenders may hold a cushion above the amount needed. Federal law caps this at two months of escrow payments. At closing you will typically fund several months of reserves to establish it.

This is why cash to close exceeds down payment plus closing costs — the reserves are your money going into your account, but they still have to arrive.

The annual analysis

Once a year the servicer reconciles what was collected against what was paid and projects the next twelve months. Three outcomes:

• Surplus — over $50 must be refunded to you
• Shortage — you may pay it as a lump sum or spread it over twelve months
• Deficiency — the account went negative; repayment terms are shorter

A shortage usually produces a double increase: the new higher monthly amount, plus the catch-up for the past year. This is why an escrow increase can feel disproportionate to the tax rise that caused it. The catch-up portion drops off after twelve months.

The most common cause of a nasty first-year surprise

New construction. The initial escrow is often set using the tax bill on the unimproved land, because that is the only assessment that exists. Once the county assesses the completed house, the bill can multiply several times over — producing a large shortage and a sharp payment increase in year two.

If you are buying new construction, ask the lender to estimate escrow on the expected completed assessment, and budget accordingly. Not every lender does this by default.

Waiving escrow

Many lenders allow a waiver at 80% LTV or below, sometimes for a small pricing adjustment — often around 0.125% in fee.

The case for waiving: you keep the money and any interest until the bills are due, and you control the timing. If you are disciplined and can absorb a $6,000 tax bill arriving at once, you come out slightly ahead.

The case against: it requires genuine discipline. A missed property tax bill creates a superior lien and, in the worst case, a tax sale. Most people are better served by the forced saving.

Note that some loan types — FHA among them — do not permit waiver at all, and high-LTV conventional loans generally cannot waive either.

If you think the account is wrong

You are entitled to the annual escrow statement showing every transaction. Check the tax and insurance figures against your actual bills. Servicing transfers are a common source of errors, and mistakes do occur — but they are usually clerical and correctable once you point to the specific line.

Common questions