For many, home ownership means taking out a mortgage for 15 or 30 years. To make things easier and protect their own interests, many lenders will pay your property taxes and homeowner’s insurance using money they set aside in an escrow account funded by part of the payment you make each month. The initial escrow disclosure is a document you’ll be provided at closing that summarizes how much you’ll pay each month for the coming year, as well as an initial payment.
Initial Escrow Disclosure Definition
When you take a loan to buy a house, an escrow account is created to set money aside each month to pay expenses like property taxes and homeowner’s insurance. The term escrow refers to a third-party service that holds funds for two parties until the money has been authorized to transfer. In the case of a homeowner’s escrow account, the expenses are typically paid once or twice a year, but money is set aside from the monthly mortgage payment to take care of the bill when it comes due.
At closing, you will receive an Initial Escrow Disclosure, which is a sheet that details how much of your monthly payment will go into that escrow account. In some cases, you’ll be asked to make an initial escrow deposit, which will be detailed as part of your loan estimate. If you placed earnest money in escrow when you put an offer on the house, that can be applied to the down payment costs at closing.
Initial Escrow Account Disclosure Statement
At closing, you’ll find an Initial Escrow Account Disclosure Statement in the stack of paperwork you’re given to review. This will clearly spell out how much will be taken out of your mortgage each month and put into the escrow account. At the top, you’ll find the amount of each payment that will go toward principal and interest and to escrow, with the total monthly payment beneath it.
The statement will also show how much each month will be put into the escrow account for the first year. This is after the initial escrow payment has been taken into account. Your escrow account will also have a cushion to protect the lender in case insurance or taxes increase over the year.
Escrow Funding Requirements
There are federal regulations limiting how much a lender can require in that initial deposit. Your lender will only be allowed to withdraw enough money to pay your bills each year, along with a $50 cushion. Check your Initial Escrow Account Disclosure Statement carefully to make sure your lender isn’t charging too much.
If a borrower wants to avoid the initial deposit, the escrow requirement can be waived, but you’ll likely need to provide a 20 percent down payment to qualify. However, lenders will charge a fee, typically 1/4 to 3/8 of a point, for circumventing the escrow process. You’ll need to make sure your property tax and homeowner’s insurance is being paid.
Annual Escrow Reconciliation Statement
In addition to your initial escrow deposit, you’ll be paying into your escrow account with every mortgage payment. The amount you’re paying during the first year is based on the calculations your lender did at closing. But your property tax and homeowner’s insurance costs can easily change from one year to the next, so that amount won’t remain fixed for the duration of your loan.
Each year, your mortgage company will conduct something called a reconciliation, which looks at how much money has come in and gone out of your escrow account in the previous year. If you didn’t pay enough in to cover your costs, you’ll get a bill in the mail for the deficit. But if that reconciliation reveals that your insurance and taxes were lower than estimated, you’ll get a check for the overage.
Adjusting Your Escrow Payments
Your initial escrow payment and first year’s payments will give your lender a baseline for figuring your total due moving forward. After a check or bill is issued to cover any discrepancies, your mortgage company will refigure your next year’s payments and adjust your mortgage payments accordingly. That means the monthly bill you’re paying every month won’t remain the same from one year to the next.
Each year, your lender will divide your total year’s property taxes and homeowner’s insurance into 12 equal payments and add that to your base mortgage payment, which includes interest and principal. The cushion amount will always be limited by law, so it shouldn’t change even though your monthly payments will.
Why Property Taxes Change
Your initial escrow deposit and first-year projections are based in part on the property taxes assessed on your home at that time. Your home’s value will not remain the same throughout the time you live there. Ideally, the value will go up, ensuring you’ll quickly build equity. However, with an increase in value also comes an increase in property taxes due.
Typically, property value is assessed every year, although each jurisdiction handles things differently. Your value may be based on factors like the current values of other homes in the area or a basic assessment rate applied to all properties in that area. Whatever the process used, your mortgage company will need to account for any sudden changes in value and adjust accordingly during the reconciliation process.
Why Homeowner’s Insurance Premiums Change
Part of your initial escrow payment and monthly payments will go toward paying your homeowner’s insurance premiums. As with other types of insurance, these rates can easily increase from one year to the next. Even if you don’t have a claim, insurers can increase rates to account for things like the cost of living.
There are things you can do to keep your premiums low, including looking for any discounts you may have missed when you initially signed up. If your rates went up and you don’t know why, feel free to reach out to your insurer and ask questions. Also, even though your bill is paid through your mortgage company, you can price around and change insurers at any time. You’ll just need to connect your new insurer with your lender to make sure everything is paid.
Annual Escrow Account Statement
Escrow accounts are based on a one-year period. At the end of that period, not only do they need to do a reconciliation, but they must send you an annual statement within 30 days. The statement will include the payments that were made over the previous year, as well as a projection for the year to come.
Your Escrow Account Statement should also include details you saw in the Initial Escrow Disclosure Statement, including how much you’re paying each month and the amount of that going toward your homeowner’s insurance and property taxes. In the statement, you’ll see how much remains in the escrow account from the previous year’s collections and how any deficiencies or overages are being handled.
Eliminating Your Escrow Account
This may not be mentioned in your Initial Escrow Account Disclosure Statement, but you can request to eliminate your escrow account at any point during the life of your mortgage. When you’re handing money over to your lender, you’re essentially giving an interest-free loan. You could keep that money in your own account and earn interest on it until the bill comes due. Lenders will often have rules in place about this, like that the loan must be at least a year old, so you’ll need to check into that before proceeding.
If you are allowed, and you are prepared to pay your own homeowner’s insurance premiums and property taxes, you’ll have to get in touch with your lender to determine the procedure. You’ll then need to take over paying those bills on time, including making sure the bills are coming to you rather than going to the lender. Your mortgage company may require that you turn in proof that you paid these bills.
Escrow and the Buying Process
When you’re buying a home, closing probably won’t be the first time you hear about escrow. In fact, when you decide to put an offer on a house, one of the first things your real estate agent will mention is something called earnest money. This shows you’re serious about buying the property, and the money will be put toward your down payment at closing.
As with your initial escrow deposit, your earnest money must be put in an escrow account and left untouched until closing. This explains why you’ll often hear of a house being “in escrow” after a contract has been accepted. There are instances in which the earnest money can be refunded, such as when the house doesn’t appraise for the purchase amount or can’t pass inspection with reasonable repairs.
It's important to note that the earnest money you paid at contract signing is not the same as the initial escrow deposit you’ll pay at closing. That escrow deposit helps get your homeowner’s insurance and property tax payments started. The earnest money was submitted with your contract to give the seller the confidence necessary to take the house off the market, in essence holding it for you. Your earnest money will go toward your down payment, but your initial escrow deposit will be part of the closing costs you’ll be asked to pay.
What Are Escrow Agents?
To keep things on the up and up, real estate agents will typically work with a third party to hold funds for clients. This brings the need for an escrow agent, also known as a title agent. The escrow agent is responsible for not only taking ownership of the funds but also reviewing all documents to ensure the transaction meets regulations.
In the case of mortgage-based escrow funds, the escrow agent is often the title company. Since the title company participates in the closing process, this makes sense, as the title company can handle the earnest money and initial escrow deposit parts of closing. No matter who manages escrow, though, it’s important that it is a neutral third party that can act in the interests of the seller and buyer and make sure everything is legal.
Escrow Outside of Real Estate
Although escrow is most often associated with real estate transactions, it also exists outside of the industry. If you’re conducting any type of financial transaction, you can benefit from having the funds stored in a neutral place. Even sites like eBay provide a level of protection for sellers and buyers since a transaction can be disputed if something goes wrong. Without this protection, you’re taking a risk on getting defective products or fraudulent payment.
Small businesses can especially benefit from escrow services, even for smaller transactions. If a client hires a marketing firm to put in hours of work, escrow will put that money in a neutral place until the work is completed to the client’s satisfaction. The funds can then be released by the payer as soon as work is completed, and the escrow account relieves the marketing firm from the risk of not being paid.
- The Mortgage Reports: Mortgage Closing: Why Does My Lender Want so Much Escrow Money?
- Select Portfolio Servicing: Escrow FAQ
- ValuePenguin: What is Escrow in a Mortgage, and Why is it Needed?
- ConsumerFinance.gov: Initial Escrow Disclosure
- ConsumerFinance.gov: What Is an Initial Escrow Deposit?
- Investopedia: Understanding the Escrow Process and Requirements
- Gold Star Mortgage Financial Group: Dissecting the Mortgage Reconciliation Process
- Nolo: How to Get Rid of Your Mortgage Escrow Account
- Investopedia: Your Property Tax Assessment: What Does It Mean?
- PolicyGenius: Why Did My Homeowners Insurance Rates Go Up?
- Consumer Financial Protection Bureau: § 1024.17 Escrow Accounts
- Investopedia: Escrow Agent
- Provident Trust Group: Escrow Services Are Used for More than Just Real Estate!
- Revere Bank: How Do Escrow Services Work for Small Businesses?
Stephanie Faris has written about finance for entrepreneurs and marketing firms since 2013. She spent nearly a year as a ghostwriter for a credit card processing service and has ghostwritten about finance for numerous marketing firms and entrepreneurs. Her work has appeared on The Motley Fool, MoneyGeek, Ecommerce Insiders, GoBankingRates, and ThriveBy30.