Understanding the Basics of Escrow

Getting a mortgage and purchasing a home is a big decision with several steps involved in the process. One part that is sometimes confusing is understanding what the mortgage escrow account is and how the escrow process works. 

To simplify this part of the mortgage process, we have provided a quick explanation of escrow.

What is escrow?
Escrow is a process where additional money is collected, along with the periodic mortgage payment, and specifically used to pay taxes and home insurance premiums. This additional payment amount is deposited into a separate account established for this purpose called an escrow account. Funds held in an escrow account can only be used to pay property taxes and home insurance premiums.

What are the benefits of having an escrow account?
An escrow account ensures that the homeowner has enough money to pay property taxes and home insurance premiums. Holding these funds in escrow keeps the homeowner from having to separately save and pay large lump sums at one time since taxes and insurance payments may add up to large amounts.

How is the escrow amount calculated?
The formula for calculating escrow is fairly simple. The total tax and insurance bills for the following year are calculated with the sum then divided by the number of payments per year. The additional amount is then added to the mortgage payment. Any changes in insurance premiums or property tax rates that occur after this calculation will alter the amount of escrow added to the mortgage payment. This calculation is done annually. Some lenders also provide an "escrow cushion" where an additional dollar amount is added to help avoid shortages.

How are taxes and insurance paid through escrow?
The mortgage company deposits the additional money collected into the escrow account and uses those funds to pay the insurance premium and property taxes on behalf of the homeowner when they become due. Typically, the insurance company will bill the lender directly for home insurance premiums. For property taxes, the local taxing authority will send the tax bill to the mortgage company which then pays the bill. Having an escrow account helps ensure that insurance payments and property taxes are paid on time. 

Do I qualify for a tax exemption?
Depending on the regulations of your local taxing authority, you may or may not qualify for a tax exemption. A few reasons you may qualify for a tax exemption could be
  • If you are a disabled 
  • If you are a disabled veteran
  • If you pay the mortgage and live in the home

There are several other scenarios that could qualify you for a tax exemption. To find out if you qualify, contact your local property assessor.


Check out the full Escrow guide for helpful information on mortgage escrow.