First-Home Q&A · 11 of 13
Nearly everyone who buys a first home asks the same thing when the first mortgage statement arrives: “I thought I was paying principal and interest. Why is it this much?”
The answer is the escrow account.
What it is
An escrow account is one the mortgage lender keeps to manage your property tax and homeowners insurance for you. The monthly payment bundles principal, interest, taxes and insurance — PITI — into one figure.
Principal and interest go to the lender. The tax and insurance portions sit in escrow until the town and the insurer come due, and the lender pays them on your behalf.
Why the bank collects your taxes
Because it is protecting the collateral, which is the house.
Unpaid property tax lets the town place a tax lien on the property, and that lien outranks the lender’s mortgage. A lapsed insurance policy means a fire or a flood can erase the collateral entirely. Both are risks to the lender’s money, so the lender manages them directly.
That is why loans with less than 20% down almost always require escrow. The smaller the down payment, the larger the lender’s exposure, and the closer the supervision.
The cushion you fund at closing
At closing you pre-fund the account with several months of tax and insurance so it is not empty when the first bill comes due.
That money is part of your closing costs. Leave it out of your planning and the cash you need on closing day will be larger than you expected. The Loan Estimate lists the initial escrow deposit as its own line — look for it there.
Why the payment changes every year
This is how a fixed-rate mortgage still ends up with a different payment. Property tax changes when the town revalues; insurance changes at renewal.
Once a year the lender runs an escrow analysis. If it paid out more in tax and insurance than it collected, there is a shortfall, and it either raises next year’s monthly payment or bills the shortfall at once. If it collected too much, it refunds the surplus or lowers the payment.
So when the annual escrow statement arrives, read it rather than filing it. The reason your payment moved is written there.
What to actually do
- On the Loan Estimate, find the full PITI figure and the initial escrow deposit. Budgeting on principal and interest alone is the mistake.
- Include the escrow cushion when you count closing cash.
- When the first escrow analysis arrives, check how the town revaluation and the insurance renewal were applied.
Escrow is not complicated; it is unfamiliar. I read these documents with clients in Korean and in English. Send a request and we will start there.
Questions
Common questions
Do I have to have an escrow account?
With less than 20% down, most lenders require one. With 20% or more, some lenders let you waive escrow and pay property tax and insurance yourself, but those bills then arrive a few times a year in large amounts, so you have to set the money aside on your own.
Why did my monthly mortgage payment go up?
Usually the escrow portion changed, not the loan. Once a year the lender runs an escrow analysis comparing what it actually paid in property tax and insurance against what it collected; a shortfall raises next year's monthly payment or is billed in one sum. A town revaluation or an insurance renewal is the usual cause.
Sources
Written by Diana Yeji Kim — REALTOR® at eXp Realty, serving Greater Boston in English, Korean, and Japanese.
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