Mortgages are typically made up of four parts–principal, interest, taxes and insurance. Put together, these comprise so-called PITI and make up your monthly mortgage payment. Since taxes and insurance are typically paid annually or semi-annually, they are usually held in escrow by the lender or another company servicing the loan. You pay into your escrow balance each month with your regular payment, and your taxes and insurance when due are automatically paid from that account.
If your mortgage is escrowed, then your monthly payment is split into three parts. Two parts go towards principal and interest, according to your loan’s amortization schedule. Initially, most of your monthly payment initially covers interest. Over time, more will go toward your principal.
The third part of your payment goes towards your escrow balance. In many mortgages funds are held in escrow to pay property taxes and homeowners insurance. When your taxes or property insurance is due, the company servicing the loan will take the money out of your escrow balance to pay those bills.
Many lenders require escrow accounts to protect their investment and ensure taxes and insurance are paid.
You can’t access the money in your escrow account and banks generally don’t pay interest on your escrow balance.
Periodically the escrow company will do an escrow analysis which may cause your monthly payment to change
Not all banks require you to escrow money for taxes and insurance. FHA loans require an escrow account. This protects the bank’s investment in your property by making sure the taxes and insurance get paid. You can escrow your taxes and insurance even if your lender doesn’t require it. This may simplify budgeting for these expenses.
Typically you can’t access the money in your escrow balance–that money is held by the lender or loan servicing company escrow company on your behalf. In most cases, the bank doesn’t pay interest on your escrow balance. The total held in your escrow account is generally included in your monthly mortgage statement or your online account information.
The government requires lenders to regularly analyze the amount of money in your escrow account. While most lenders do this annually, they may analyze your account more often if the amount you owe for taxes and insurance changes.
During escrow analysis, the lender calculates the amounts that will come due for property taxes and homeowners insurance in the coming year. As an example, say the upcoming year looks like this:
January – $2,500 in semiannual property taxes
April – $1,000 for hazard insurance
July – $2,500 for the 2nd half property taxes
With $6,000 in expected yearly outlays coming up, the lender will divide that by 12 to get a $500 monthly payment towards your escrow account. Government regulations also allow escrow companies to maintain an extra amount in your account as a cushion in case unexpected payments arise. So depending on your escrow balance, your monthly payment may be slightly more than the total expenses divided by 12.
When your lender performs their escrow analysis, they will send you a statement, either by mail or in your online account. This statement will detail the results of the escrow analysis, and your new monthly payment amount.
Your escrow balance is the amount of money that is held for you in your escrow account (also called an impound account in some areas of the country). You pay into your escrow account each month as part of your regular mortgage payment. Not all lenders require an escrow account, though many do. Even if your lender doesn’t require it, many people prefer having an escrow account since it makes budgeting for these expenses easier.