What is an escrow account and how does it work?

Buying a home comes with many new financial responsibilities, including property taxes and homeowners insurance. Escrow accounts are a way for your lender to help you manage these expenses by including them in your mortgage payment.

Note: Another type of escrow account may be used during the homebuying process to hold a buyer’s earnest money deposit. That type of escrow account is not related to the one used for taxes and insurance.

When you purchase or refinance a home, your lender may establish an escrow account to pay for property taxes and homeowners insurance, as well as other expenses like flood insurance and private mortgage insurance (PMI).

Every time you make a mortgage payment, part of it will go into the escrow account. When your property tax and insurance bills are due, your lender pays them on your behalf using the funds in your account.

Escrow accounts are not used for homeowners association (HOA) fees or some supplemental tax bills. The homeowner usually pays these payments directly.

Using an escrow account to manage your taxes and insurance payments can offer important benefits.

• One mortgage payment covers multiple expenses. You don’t have to save or pay for your taxes or insurance separately because your lender does it on your behalf, which means fewer bills you need to track.
• Large expenses get broken down into smaller monthly payments. Instead of getting hit with large insurance and tax bills that may come to thousands of dollars each year, the cost is spread evenly across your monthly mortgage payments.
• Your property tax and insurance payments stay up to date so you stay protected. Falling behind on taxes or insurance can lead to financial and legal consequences that no homeowner wants to deal with. Having an escrow account can help ensure you stay on top of these expenses with the help of your lender.

Your monthly mortgage payment would increase by approximately 1/12 of the expenses your escrow account covers.

For example, let's say your taxes and insurance add up to $3,000 per year. If you divide that number by 12, your monthly payment increases by roughly $250. The mortgage services may also include a small cushion in the escrow account, and the amount can change if taxes or insurance premiums change.

Each year, your lender will perform what is called an escrow analysis, which helps ensure there will be enough funds in the account to cover property tax and insurance payments. This process involves reviewing the account activity from the previous 12 months and making projections for the upcoming 12 months. 

Your lender will provide these details in your annual escrow analysis statement. Your statement will also let you know if your monthly escrow payments will change for the coming year and whether there is a shortage or surplus in your escrow account.

Not every mortgage requires an escrow account. Escrow requirements for mortgage loans vary between lenders and usually depend on several factors such as:

• Down payment amount
• Loan-to-value ratio (LTV)
• Loan type

For example, Federal Housing Administration (FHA) loans always require escrow accounts. Talk to your lender before closing about escrow requirements, and if it’s possible to waive escrow at closing if you think that might be a better option for you.

An escrow waiver at closing means you are opting not to use an escrow account, thereby not including property tax and insurance payments in your monthly mortgage payments. You may wish to utilize an escrow waiver if you want to house your money in an interest-accruing account.

However, there are risks associated if you wish to pursue an escrow waiver. Namely, it is important to know your financial expectations, as you will now be responsible for making the property tax and insurance payments directly.

There are many factors that can determine if you’re eligible to qualify for an escrow waiver at closing, including what type of loan you have, the property you purchased, your LTV, and other factors determined by your lender or your state of residence. Please note you may need to pay a fee to complete an escrow waiver.

If you have a conventional home loan, you’ll typically need more than 20% equity in your home, plus a history of no recent mortgage delinquencies, defaults, or loan modifications. These are general guidelines and can vary based on your lender and their policies.

If you have a VA loan, your lender may require you to have an escrow account.

If you have an FHA loan, you are required to use an escrow account.

If you have questions about accessing an escrow analysis or escrow waiver, you can find out more information in your mortgage account or you can download the Wells Fargo Mobile^® app where you can manage your account and get additional support.