If you have a mortgage, you’ve likely heard the term “escrow account.” It’s a common part of the homebuying process, but many homeowners aren’t entirely sure how it works, especially when it comes to paying property taxes. Understanding this process is key to managing your home finances effectively and avoiding any unwelcome surprises from your local tax authority.
This guide will explain exactly what an escrow account is and how it’s used to manage your property tax payments. We’ll walk through the step-by-step process, highlight the benefits, and help you understand why your lender sets it up this way. By the end, you’ll have a clear picture of how this system works for you.
What Is an Escrow Account for Property Taxes?
An escrow account is a special savings account managed by your mortgage lender. Its purpose is to hold funds for certain homeownership-related expenses, primarily your property taxes and homeowners’ insurance premiums. Instead of you paying these large bills directly in lump sums once or twice a year, your lender collects a portion of the total estimated cost with each monthly mortgage payment.
Think of it as a savings plan for your major housing expenses.
- Principal: The portion that pays down your loan balance.
- Interest: The cost of borrowing the money.
- Taxes: The portion that goes into your escrow account for property taxes.
- Insurance: The portion that goes into your escrow account for homeowners’ insurance.
The lender holds the Taxes and Insurance portions in your escrow account and then pays your tax and insurance bills on your behalf when they are due.
How Property Taxes Are Paid Through an Escrow Account
The process of paying property taxes through an escrow account is straightforward and designed to be seamless for the homeowner. Here is a step-by-step breakdown of how it works from start to finish.
1. Estimating Your Annual Costs
When your loan is originated, and typically once a year thereafter, your lender estimates your total annual property tax and homeowners’ insurance costs. To get the property tax amount, contact your local tax authority to find out the current tax rate and your property’s assessed value. They divide this total annual cost by 12 to determine the monthly amount they need to collect from you.
For example, if your annual property tax bill is $3,600 and your homeowner’s insurance premium is $1,200, your total annual escrow expenses are $4,800.
$4,800 / 12 = $400 per month for escrow.
This $400 is added to your monthly principal and interest payment. Lenders are also legally allowed to collect a cushion, usually two months’ worth of escrow payments, to cover any unexpected increases in your tax or insurance bills.
2. Funding the Account at Closing
When you first close on your home, you’ll likely make an initial deposit into your escrow account. This “prepaid” deposit helps to ensure there are sufficient funds to pay the first tax and insurance bills, which may come due before you’ve made enough monthly payments to cover them.
3. Making Monthly Payments
Each month, you make a single payment to your mortgage lender. A part of this payment is automatically deposited into your escrow account. The lender holds these funds until your property tax bill is due.
4. Paying the Bill
When your property tax bill comes due (this could be annually, semi-annually, or quarterly, depending on your municipality), your mortgage servicer takes the money from your escrow account and pays the bill directly to your local tax authority on your behalf. You typically receive a copy of the tax bill from the municipality for your records, but your lender handles the actual payment.
5. Annual Escrow Analysis
Once a year, your lender will conduct an “escrow analysis.” They review the past year’s activity, comparing the amount they collected with the actual amount they paid out for your taxes and insurance.
- If there is a surplus: If they collected more money than was needed, you might receive a refund check, or the lender may apply the surplus to your future escrow payments.
- If there is a shortage: If your property taxes or insurance premiums increased, your account may not have had enough funds to cover the bills. The lender will cover this shortage, but you will need to repay it. You can usually do this in a lump sum or by having your monthly escrow payment increased over the next 12 months to cover the shortage and the new, higher annual cost.
This annual adjustment is why your monthly mortgage payment can vary from year to year, even with a fixed-rate loan.
The Benefits of Using an Escrow Account
For many homeowners, paying property taxes through an escrow account offers significant advantages.
- Simplified Budgeting: Escrow rolls your large, infrequent tax and insurance bills into smaller, predictable monthly payments. This makes it much easier to budget your household expenses and avoid money mistakes without having to save up for a large lump-sum payment.
- Timely Payments: Your lender is responsible for making sure your tax and insurance bills are paid on time. This removes the risk of you forgetting a due date and incurring costly late fees or, in a worst-case scenario, a tax lien on your property.
- Peace of Mind: Knowing that your major housing expenses are being automatically handled can reduce financial stress. You don’t have to worry about setting money aside or remembering payment deadlines.
Your lender’s requirement for an escrow account is typically based on factors like your loan type and the size of your down payment.
- FHA and USDA loans: These government-backed loans typically require an escrow account for the life of the loan.
- Conventional loans: If you make a down payment of less than 20%, your lender will almost certainly require an escrow account to protect their investment.
If you have a conventional loan and your loan-to-value (LTV) ratio is 80% or less, you may have the option to waive escrow. However, lenders might charge a fee for this or require a slightly higher interest rate. If you choose to waive escrow, you are fully responsible for paying your property taxes and homeowners’ insurance on time.
A Balanced Approach to Homeownership
An escrow account simplifies homeownership by bundling your property taxes and homeowners’ insurance into your monthly mortgage payment. Your lender manages the funds and ensures your bills are paid on time, offering you convenience and peace of mind. While payment fluctuations are possible, the system is designed to protect both you and your lender from the risks of missed payments. Whether you’re navigating escrow for the first time or reviewing your annual analysis, staying informed is key to confident homeownership. If you have questions about your escrow account, reach out to the mortgage experts at Heritage Bank NA.
