What is escrow? How it works when you buy a home

Escrow is an arrangement where a neutral third party holds money until both sides of a deal meet agreed conditions. When you buy a home, escrow usually holds your earnest money while the sale moves toward closing.

After you buy, your mortgage servicer may also collect money each month in an escrow account to pay your property taxes and homeowners insurance. Knowing how both kinds of escrow work helps you plan for closing costs and your monthly housing bill.

Key takeaways

• Escrow holds money or documents until the conditions in an agreement are met.
• When you buy a home, escrow holds your earnest money and closing funds until the sale closes.
• A mortgage escrow account collects part of each monthly payment to cover property taxes and homeowners insurance.
• Federal rules limit how much extra a servicer can keep in your escrow account and say when it must refund a surplus.

How escrow holds money until conditions are met

The roles of the buyer, seller and escrow agent

As the buyer, you deposit earnest money into escrow to show you intend to complete the purchase. The seller agrees to the sale terms. The escrow agent, often a title or escrow company, holds and manages the money and documents according to the written escrow instructions.

Those instructions spell out what must happen before the agent releases anything. Conditions can include finishing inspections, getting loan approval and signing closing documents. Once the conditions are met, the agent sends the money to the seller or applies it to your closing costs, as the agreement directs.

Purchase escrow vs. mortgage escrow

Purchase escrow covers the home sale itself. The escrow agent holds your earnest money during the transaction and pays it out at closing. If the sale falls through, the contract terms decide who gets the deposit.

Mortgage escrow runs for the life of your loan. Each month your servicer puts part of your payment into an account and uses it to pay property taxes and homeowners insurance when those bills come due. This spreads large bills across the year, though your payment changes when those costs do.

How escrow works during a home purchase

Earnest money and the purchase agreement

After the seller accepts your offer, you both sign a purchase agreement that sets the price, deadlines and conditions of the sale. You then pay earnest money, also called a good faith deposit. The escrow or title company holds it according to the agreement’s instructions.

The deposit amount and due date depend on your contract and local practice. Your agreement should say when you can get the money back, for example if an inspection or financing contingency applies. If you back out for a reason the contract doesn’t allow, the seller may be entitled to keep the deposit. Before you sign, ask your real estate agent or an attorney to walk you through the deadlines and cancellation terms.

What happens while a home is in escrow

While the sale is “in escrow,” you work through the steps and deadlines in your agreement. These usually include a home inspection, an appraisal, mortgage approval and a title search. Your lender reviews your finances and the property before approving the loan. The title company checks ownership records for claims or liens that could get in the way of the transfer.

You and the seller may also negotiate repairs or credits. Keep track of each deadline, send requested documents promptly, and get any changes to the contract in writing. The exact process varies by state, and in some states an attorney handles closing instead of an escrow company.

How funds are applied or released at closing

At closing, you review and sign the final documents and pay the amount due. That usually includes your down payment, closing costs and prepaid items such as the first deposit into your mortgage escrow account. Your earnest money is normally credited toward what you owe, as shown on your Closing Disclosure.

Once all documents and funds are in, the escrow holder pays out the money as the agreement directs. The seller receives the sale proceeds after their mortgage and costs are paid off, and the deed is recorded in your name. If the sale ends before closing, the escrow holder releases the deposit according to the contract or signed instructions from both parties.

How a mortgage escrow account pays your housing bills

What the monthly escrow payment covers

A mortgage escrow account, called an impound account in some states, holds money your servicer collects for bills tied to your home. The main ones are property taxes and homeowners insurance. Many lenders require an escrow account so they know those bills get paid, and some loans require one by law.

Your monthly mortgage payment is often described as PITI: principal, interest, taxes and insurance. If your loan requires mortgage insurance, such as private mortgage insurance (PMI) or an FHA mortgage insurance premium, that is usually included too. HOA dues usually aren’t, so check your loan documents and statement.

An example of an escrow payment

Suppose your yearly property tax bill is $3,600 and your homeowners insurance costs $1,200 a year. Together that’s $4,800, or $400 a month. Your servicer would add about $400 to your monthly principal and interest payment to cover those bills.

Federal rules also let the servicer hold a cushion of up to one-sixth of the year’s expected bills, which is two months of escrow payments. In this example the cushion could be up to $800. Your loan documents or state law may set a lower limit.

How the servicer pays bills when they’re due

You pay your servicer each month, and it moves the escrow portion into your escrow account. When the property tax or insurance bill comes due, the servicer pays it from that account. You don’t usually pay those bills yourself, but it’s worth checking your statements to make sure the tax amount and insurance policy are correct.

If you switch homeowners insurance companies, tell your servicer right away so it pays the new policy and not the old one.

Why escrow payments change

Annual escrow analysis

Your servicer reviews your escrow account at least once a year. This escrow analysis compares what’s in the account with the bills expected over the next 12 months, then sets your new monthly escrow payment. The servicer must send you an annual escrow statement within 30 days of the end of the account year.

If your property tax bill or insurance premium goes up, your monthly payment goes up too, even on a fixed-rate mortgage. Compare the statement with your tax bill and insurance notices so you can spot mistakes.

Escrow shortages

A shortage means the account will be short of what’s needed to pay the coming year’s bills and keep the allowed cushion. Federal rules limit how a servicer can ask you to make it up:

• Shortage of less than one month’s escrow payment: the servicer can leave it alone, ask you to repay it within 30 days, or spread it over at least 12 monthly payments.
• Shortage of one month’s escrow payment or more: the servicer can leave it alone or spread it over at least 12 monthly payments. It can’t demand a lump sum, though many servicers let you pay one if you choose.

A shortage can raise your payment for two reasons at once: higher expected bills for the coming year, and repayment of last year’s gap.

Escrow surpluses

A surplus means the account holds more than it needs. If the surplus is $50 or more and you’re current on your mortgage payments, the servicer must refund it to you within 30 days of the analysis. If it’s less than $50, the servicer can either refund it or credit it toward next year’s payments.

Escrow costs, rules and waivers

Escrow fees and upfront funding at closing

Your closing costs may include a fee for the escrow or settlement services on your purchase. Who pays it depends on local practice and your contract. Check your Loan Estimate and Closing Disclosure for the exact charges.

You’ll usually also make an initial deposit into your mortgage escrow account at closing. The size depends on when your tax and insurance bills fall due and how many monthly payments you’ll have made by then, plus any cushion. The servicer must give you an initial escrow account statement at closing or within 45 days of it.

When you may be able to waive escrow

An escrow waiver lets you pay your property taxes and homeowners insurance yourself. Whether you qualify depends on your lender and loan type. Lenders often look at your equity or down payment, credit and payment history, and some charge a fee to waive escrow.

Some loans don’t allow a waiver:

• FHA loans require an escrow account for taxes and insurance.
• Higher-priced mortgage loans, a federal category for loans with a rate well above the average offered rate, must have an escrow account for at least five years. After that you can ask to cancel it, as long as you owe less than 80% of the home’s original value and you’re not behind on payments.

If you do waive escrow, set money aside for large bills and pay them on time. If you fall behind on taxes or insurance, your lender can add an escrow account to your loan or buy insurance for you and bill you for it, which usually costs more than a policy you’d buy yourself.

Escrow outside of home buying

Escrow isn’t only for real estate. Online escrow services hold your payment while a seller ships an item or finishes agreed work, then release it once you confirm delivery. This can help when you’re buying something expensive from someone you don’t know.

Be careful: fake escrow websites are a common scam. Before paying, confirm the service is legitimate, that both sides agreed to use it, and that the payment instructions come from the service’s own website, not a link someone sent you.

In business deals, escrow agents can also hold stocks, deeds or other documents until the conditions in an agreement are met.

Frequently asked questions

How does escrow work when buying a house?

After you and the seller sign a purchase agreement, an escrow holder keeps your earnest money and manages the funds and documents needed to close. It releases the money and records the transfer once the sale’s conditions are met, such as inspections and loan approval.

What is a mortgage escrow account used for?

It collects part of your monthly mortgage payment to pay your property taxes and homeowners insurance, and sometimes mortgage insurance. The servicer pays those bills from the account when they’re due.

How is an escrow payment calculated?

The servicer adds up your expected yearly property tax and insurance bills and divides the total by 12. If those bills total $4,800 a year, the escrow part of your payment is about $400 a month. The servicer may also collect a cushion of up to two months of escrow payments.

What happens to escrow money if a home purchase falls through?

It depends on your purchase agreement and why the sale ended. If you cancel within a contingency, such as a failed inspection or financing falling through, you usually get the deposit back. The escrow holder releases the money according to the contract or signed instructions from both parties.

Do you get unused escrow money back?

Yes, in two cases. If the annual analysis finds a surplus of $50 or more and you’re current on payments, the servicer must refund it within 30 days. And when you pay off your mortgage, the servicer must return any remaining escrow balance within 20 business days, unless you agree to move it into a new escrow account, such as when you refinance with the same servicer.

Can you remove escrow from a mortgage?

You can ask your servicer to cancel it. Approval depends on your loan type, equity, payment history and the lender’s rules. FHA loans require escrow, and higher-priced mortgage loans must keep it for at least five years. If removal is approved, you’ll pay your property taxes and homeowners insurance directly.