Escrow and Mortgage: What’s Included and How It Works

Most homeowners pay into escrow accounts monthly without fully understanding what they’re funding or why their payment changes annually. Then an escrow shortage notice arrives, announcing a payment increase that strains your budget—and you’re confused about what happened and whether you even need escrow.

An escrow account collects a portion of your property taxes and insurance premiums with each mortgage payment, holding these funds until the bills come due. Your lender pays your taxes and insurance from this account, preventing gaps in coverage or tax delinquencies. It’s designed to protect both you and the lender from financial surprises.

In this guide, you’ll discover:

• How escrow accounts work and what they include (following RESPA regulations)
• What’s included in mortgage escrow (taxes, insurance, sometimes HOA)
• Monthly payment calculation and escrow analysis process
• Escrow shortage versus surplus and what happens with each
• Cushion requirements and why lenders hold reserves (understanding lending requirements)
• Waiving escrow options and when it makes sense
• Managing escrow changes when taxes or insurance increase

Whether your payment just increased due to escrow adjustment, you received a shortage notice, or you’re simply trying to understand what you’re paying for, demystifying escrow accounts helps you manage this required component of homeownership.

Questions about your escrow account? Schedule a call to discuss your mortgage payment structure.

What Is an Escrow Account?

An escrow account (also called an impound account) is a holding account your mortgage servicer maintains to collect and pay your property taxes and insurance premiums as they come due.

How escrow works:

1. Your lender estimates annual property taxes and insurance costs
2. They divide this total by 12 months
3. You pay this amount along with principal and interest monthly
4. Lender holds these funds in escrow account
5. When tax and insurance bills arrive, lender pays them from the account
6. Process repeats continuously throughout loan life

Your total monthly payment (PITI):

• Principal (loan paydown)
• Interest (borrowing cost)
• Taxes (property taxes held in escrow)
• Insurance (homeowners insurance and possibly PMI held in escrow)

Why escrow exists:

• Prevents tax liens (if you don’t pay property taxes)
• Ensures continuous insurance coverage (protects lender’s collateral)
• Spreads large annual expenses into manageable monthly amounts
• Protects you from forgetting or missing major payments

Example monthly breakdown:

• Principal & Interest: Based on loan amount and rate
• Property Taxes (escrowed): Annual tax divided by 12
• Homeowners Insurance (escrowed): Annual premium divided by 12
• PMI if applicable: Monthly premium
• Total monthly payment: Combined amount

You’re not losing this money—it’s just being collected monthly and paid on your behalf rather than you paying lump sums directly.

What’s Included in Mortgage Escrow?

Standard escrow accounts typically include property taxes and homeowners insurance, though what’s actually escrowed varies by loan type and situation.

Property Taxes

Your local property taxes are almost always escrowed when you have a mortgage.

How property tax escrow works:

• County assesses your property value annually
• Tax rate applied determines annual tax bill
• Lender receives tax assessment information
• Lender collects 1/12th of annual taxes monthly
• When taxes due (annually or semi-annually depending on location), lender pays from escrow

Property tax changes impact your payment: If your assessment increases or tax rates rise, your escrow payment increases. If they decrease, your payment could decrease.

Homeowners Insurance

Your hazard insurance premium is included in escrow to ensure continuous coverage protecting the property securing your loan.

How insurance escrow works:

• Your insurance premium renews annually
• Lender receives renewal notice and premium amount
• Lender collects 1/12th of annual premium monthly
• When renewal due, lender pays premium from escrow
• Coverage continues without gap

Insurance changes impact your payment: Premium increases (common) raise your escrow payment. Shopping for competitive insurance can reduce your total monthly payment.

See our guide on homeowners insurance review to understand coverage and costs.

Private Mortgage Insurance (PMI)

PMI is collected monthly but not always through escrow—depends on how it’s structured.

PMI payment methods:

• Borrower-paid monthly (most common): Included in monthly payment, may or may not technically be in escrow account
• Lender-paid: Built into your interest rate, not a separate payment
• Single premium: Paid at closing, not in monthly payment

When you can remove PMI (reaching equity thresholds or refinancing), this portion of your payment disappears. Read about removing PMI to understand your options.

HOA Dues (Sometimes)

Homeowners association dues are rarely escrowed but some lenders allow it upon request.

Most common: You pay HOA directly, separate from mortgage. If you want HOA included in escrow, ask your lender—many won’t do it, but some will.

What’s NOT in Escrow

Your mortgage payment does NOT include:

• Utilities (electric, gas, water, sewer)
• Home maintenance or repairs
• HOA dues (usually)
• Supplemental insurance (flood, earthquake unless lender-required)
• Home warranty plans

These remain your direct responsibility outside your mortgage payment.

How Escrow Analysis Works

Your lender performs an escrow analysis annually to ensure they’re collecting the right amount for your actual tax and insurance costs.

The Annual Escrow Analysis Process

What lenders do during analysis:

1. Review actual property taxes paid in past year
2. Review actual insurance premiums paid
3. Project upcoming year’s taxes (based on assessment changes)
4. Project upcoming year’s insurance (based on renewal notices)
5. Calculate required monthly collection amount
6. Compare to what they’ve been collecting
7. Determine if adjustment needed

Result outcomes:

• Shortage: They collected too little (you owe money or payment increases)
• Surplus: They collected too much (you get refund or payment decreases)
• On target: No change needed (rare—usually slight adjustment)

Understanding Escrow Statements

Your annual escrow statement shows:

• Starting balance at beginning of analysis period
• Each deposit you made monthly
• Each disbursement (tax and insurance payments made)
• Ending balance
• Projected balance for coming year
• Shortage or surplus amount
• New monthly escrow payment required

Review these statements carefully—errors happen, and you want to catch them early.

Why Escrow Shortages Happen

Common causes of shortages:

• Property taxes increased (reassessment, rate increases, special assessments)
• Insurance premiums increased (market conditions, claims)
• Initial escrow calculation was too low
• Lender paid a bill you thought you’d paid directly
• Timing mismatches between collections and disbursements

Less common causes:

• Escrow analysis errors by servicer
• Missing payments that created shortfall
• Refinancing timing created gap

Managing Escrow Shortages and Surpluses

When your annual analysis reveals shortage or surplus, you have options for how to address it:

Handling Escrow Shortages

When you have shortage, you owe the difference between what should have been collected and what actually was collected.

Shortage payment options:

• Pay full shortage immediately: Pays off deficit, monthly payment increases moderately for upcoming year’s projected costs only
• Spread shortage over 12 months: Don’t pay lump sum, but monthly payment increases more substantially to cover both deficit repayment and increased projections
• Combination: Pay partial shortage now, spread remainder over 12 months

Example shortage scenario:

• Shortage amount: Moderate deficit
• Option A: Pay lump sum immediately, payment increases moderately
• Option B: Spread over 12 months, payment increases more substantially
• Your choice: Based on cash flow and preference

Most borrowers spread shortages over 12 months to avoid large lump sum, accepting higher monthly payment.

Handling Escrow Surpluses

When you have surplus exceeding a certain amount, lender must refund or offer to apply to escrow account.

Surplus options:

• Receive refund check: Lender sends you the excess
• Apply to escrow account: Keeps funds in account, lowering your monthly payment for upcoming year

Most borrowers keep surplus in account rather than taking small refund, allowing lower monthly payment going forward.

Preventing Future Shortages

Strategies to minimize shortage surprises:

• Review property tax assessments annually and appeal if warranted
• Shop homeowners insurance annually for competitive rates
• Increase escrow payment voluntarily if you know taxes/insurance are rising
• Budget for payment increases rather than being caught off guard
• Understand your local assessment and tax cycles

Payment increases are normal—taxes and insurance rarely decrease, so expect gradual payment increases over time.

Cushion Requirements and Escrow Reserves

Lenders don’t just collect exactly what’s needed—they maintain a cushion to handle timing mismatches and unexpected increases.

Federal Escrow Cushion Limits

RESPA regulations allow lenders to require cushion up to certain limits:

• Maximum cushion: Typically two months’ worth of escrow payments
• Purpose: Protects against timing gaps and slight underestimates
• Required: Lenders must keep cushion within federal limits

Example:

• Annual property taxes: Moderate amount
• Annual insurance: Annual premium
• Total annual escrow: Combined total
• Monthly collection: Divided by 12
• Maximum allowed cushion: Two months’ worth
• Target escrow balance maintained: Collection amount plus cushion

This cushion explains why your escrow balance never hits zero—lender maintains minimum reserves.

Why Cushions Exist

Timing protection:

• Property taxes due before lender collects enough monthly
• Insurance renewal comes before sufficient funds accumulated
• Mid-year tax increases or special assessments
• Premium increases between analyses

Without cushion, lenders would need to advance their own funds more frequently, creating inefficiency.

This isn’t lender profit—it’s your money being held as buffer, ensuring sufficient funds when bills arrive.

Waiving Escrow: When You Can Pay Directly

Some borrowers can waive escrow and pay taxes and insurance directly rather than through monthly collections.

Requirements to Waive Escrow

Typical escrow waiver criteria:

• Conventional loans (not government-backed)
• Substantial equity (typically certain percentage LTV or lower)
• Strong payment history
• Lender approval and possible waiver fee
• May not be allowed on certain loan programs

FHA, VA, and USDA loans typically require escrow—no waiver option.

Jumbo loans often allow waiver with adequate equity regardless of LTV.

Pros and Cons of Waiving Escrow

Advantages of managing your own taxes and insurance:

• Control over when bills are paid
• Can earn interest on funds until due
• No cushion requirement—you hold only what’s needed
• Flexibility to change insurance on your schedule
• One less account to track and reconcile

Disadvantages of waiving escrow:

• Responsibility to pay large lump sums on time
• Risk of missing payment and creating lien or coverage gap
• Need discipline to save monthly
• Miss convenience of automatic payment
• May face penalty if you fail to pay and lender must intervene

Who should waive escrow:

• Financially disciplined homeowners
• Those who want control and can manage large periodic payments
• Borrowers who can earn meaningful interest on escrowed funds
• People who prefer managing all bills directly

Who should keep escrow:

• Anyone who benefits from forced savings
• Those who prefer not thinking about large annual/semi-annual bills
• Borrowers who value convenience over control
• Anyone who might forget or delay large payments

Managing Escrow Changes

Your escrow payment will change over time—understanding what triggers changes helps you anticipate and manage them:

Property Tax Appeals Impact

If you successfully appeal your property assessment, your escrow payment may decrease.

Process:

1. You appeal assessment and win reduction
2. County adjusts your assessed value downward
3. Next tax bill reflects lower assessment
4. Lender’s escrow analysis captures lower taxes
5. Your payment decreases at next annual analysis

Consider appealing assessments when your property’s assessed value exceeds fair market value or comparable properties’ assessments.

Insurance Shopping Impact

Reducing insurance premiums lowers your escrow payment:

1. Shop competitive insurance rates annually
2. Switch to lower-cost policy (maintain adequate coverage)
3. Notify lender of new policy and premium
4. Lender adjusts escrow collections
5. Your payment decreases

Never sacrifice coverage for lower premium—adequate protection matters more than minimal payment reduction. See our insurance review guide for tips.

Refinancing Impact on Escrow

When you refinance, your old escrow account closes and new one opens:

• Old lender refunds remaining escrow balance (usually several thousand dollars)
• New lender collects new escrow reserves at closing
• You start fresh with new escrow account and analysis cycle

This refund and recollection is normal part of refinancing—budget for it when considering whether to refinance.

How Stairway Mortgage Helps

Escrow accounts are required components of most mortgages, and we help you understand how they work and how they impact your total housing payment.

Our team helps you:

• Explain escrow requirements for different loan programs
• Calculate your total monthly payment including escrow
• Understand what’s escrowed and what you pay separately
• Evaluate whether waiving escrow makes sense for your situation
• Anticipate how tax and insurance changes affect your payment
• Budget for potential escrow adjustments over time

When refinancing, we show you how new escrow accounts work and what to expect at closing regarding escrow funds.

Questions about your mortgage escrow account? Get pre-approved and we’ll explain your complete payment structure.

Frequently Asked Questions

What happens to my escrow when I pay off my mortgage?

When you pay off your mortgage, your lender closes the escrow account and refunds the remaining balance to you within a certain period. This refund typically arrives several weeks after payoff. The amount includes any cushion and funds collected for upcoming tax and insurance payments. Going forward, you’re responsible for paying property taxes and insurance directly—budget for these large periodic payments carefully.

Can I remove escrow from my mortgage?

Maybe—it depends on your loan type and equity. Conventional loans with substantial equity (typically certain percentage or more) often allow escrow waiver. FHA, VA, and USDA loans typically require escrow throughout the loan. Contact your servicer to ask about their specific requirements and any fees for waiving escrow. Remember, waiving escrow means you must pay property taxes and insurance directly in lump sums—only waive if you’re financially disciplined.

Why did my mortgage payment increase if my interest rate didn’t change?

Your payment increased due to escrow account adjustments—property taxes or insurance premiums rose. Lenders perform annual escrow analyses comparing projected costs to actual costs. When actual costs exceed projections, you have a shortage that increases your payment. Review your annual escrow statement to see specifically which costs increased. Property tax increases (from assessments or rate changes) and insurance premium increases are common culprits.

How much should be in my escrow account?

Your escrow account balance varies throughout the year as lender collects monthly and pays periodic bills. Target balance equals upcoming bills plus a cushion (up to two months’ worth of escrow payments). Right after taxes or insurance paid, balance is lowest. Just before major payments, balance is highest. Review your escrow statement to see if your balance is appropriate—lender must keep it within federal limits.