Escrow Accounts Explained: How Lenders Handle Taxes and Insurance

An escrow account is a fund managed by your mortgage servicer that collects money for property taxes and insurance premiums. Each month, a portion of your mortgage payment goes into escrow, and the servicer pays your tax and insurance bills when they are due.

How Escrow Works

1. •Your monthly mortgage payment includes principal, interest, and 1/12 of your annual taxes and insurance
2. •The tax and insurance portions go into the escrow account
3. •When bills are due, the servicer pays them from the escrow account
4. •You do not have to manage these payments yourself

When Escrow Is Required

• •Conventional loans with less than 20% down — escrow is required
• •FHA loans — escrow is required for the life of the loan
• •VA loans — escrow is required
• •USDA loans — escrow is required

Once you reach 20% equity on a conventional loan, you may be able to request to cancel escrow and pay taxes and insurance yourself.

The Escrow Analysis

Once a year, your servicer performs an escrow analysis:

• •Reviews the actual tax and insurance costs
• •Compares to what was collected
• •If short: your monthly payment increases to cover the shortage
• •If surplus (over $50): the lender refunds the excess or applies it to your account

Escrow Cushion

Lenders are allowed to maintain a cushion of up to 2 months of escrow payments as a buffer against tax or insurance increases. Federal law (RESPA) limits the cushion.

Pros and Cons of Escrow

Pros:

• •No surprise tax or insurance bills — they are paid automatically
• •Easier budgeting — costs are spread monthly
• •No risk of late tax payments or insurance lapses

Cons:

• •Higher monthly payment (principal + interest + taxes + insurance)
• •Less control over your cash flow
• •You cannot earn interest on the escrow funds (some states require interest, but rates are minimal)

How to Cancel Escrow

On a conventional loan with 20%+ equity:

1. •Submit a written request to your servicer
2. •The servicer reviews your payment history and LTV
3. •If approved, you will pay taxes and insurance directly
4. •Your monthly payment drops to principal and interest only

Key Takeaways

• •Escrow accounts collect money monthly for taxes and insurance
• •Required on most loans with less than 20% down and all government loans
• •Annual analysis adjusts your payment if costs change
• •You can cancel escrow on conventional loans at 20% equity
• •Escrow simplifies bill management but raises your monthly payment