1. The Purpose of a Mortgage Escrow Account
An escrow account is a neutral holding account managed by your mortgage servicer to pay property taxes and homeowners insurance bills. Lenders require escrow accounts to protect their collateral from tax foreclosure and hazard loss.
Instead of paying property tax and insurance bills once or twice a year, you pay 1/12th of the estimated annual costs inside your monthly mortgage check. The servicer holds these funds in escrow and pays the bills when they fall due.
2. How Property Taxes are Assessed & Levied
Property taxes are levied by county and municipal governments to fund local services, schools, and infrastructure. Taxes are calculated by multiplying the property's assessed value by the local millage rate.
Assessed value is determined by a county tax assessor and is often lower than fair market value. However, assessed values can change annually. If your home's assessed value rises, your property tax bill will increase, raising your escrow requirements.
3. Escrow Cushions & Reserves at Closing
To protect against tax or insurance premium increases, federal law (under RESPA guidelines) allows lenders to collect and maintain an escrow cushion. The cushion can be up to two months of tax and insurance payments.
At closing, you must fund this cushion upfront. This requirement can add thousands of dollars to your closing costs, but it ensures that your escrow account does not fall into a negative balance if property expenses increase.
4. Managing Escrow Shortages and Overages
Your servicer performs an annual escrow analysis to compare projected tax and insurance costs against your actual bills. If property taxes or insurance premiums rise, you will face an escrow shortage.
To resolve a shortage, you can pay the difference as a lump sum or allow the servicer to spread the shortage over the next 12 months, which will increase your ongoing monthly mortgage payment. If taxes decrease, you will receive an escrow overage check.