What Is A Mortgage Escrow Account And How Does It Work With My Homeowners Insurance Policy?

Aug 23, 2022 | Personal Insurance

Escrow and escrow accounts are two different ideas when we discuss mortgages. You must be wondering if it’s something you would need at all, right? So, what is a mortgage escrow account, and how does it work with my homeowners’ insurance policy?

First things first

First, escrow is a neutral third party acting as a real estate dealer handling the money and property. “In escrow” until two sides of the party agree that all circumstances are for a sale as sold. An escrow account is an account that manages a mortgage, a borrower’s yearly tax, and insurance expenses.

What is an Escrow Account?

Escrow is a legal concept. This is a financial instrument wherein an asset or escrow money is by a third party on behalf of the other two parties. That is in the process of completing a particular transaction. These escrow accounts might also have escrow fees by agents who handle the funds of assets until obtaining the proper instructions or until the fulfillment of predetermined contractual obligations. You can handle money, securities, funds, and other assets in an escrow account. A similar process would be a fully funded documented letter or credit. This is often a replacement for a certified or cashier’s check.

You must have an escrow account that acts as a savings account when you have a mortgage. Your mortgage servicer manages this. It’s a simple process. He will deposit a part of each mortgage payment into your escrow account to cover your property taxes and insurance premiums.


Escrow are third-party services that are usually a requirement when purchasing a house. A house’s buyer and seller will select a neutral third party to act as the escrow agent when they arrive at a purchase agreement. The escrow agent will then collect the “earnest money” from the house buyer. This deposit is equivalent to a small percentage of the sale price. In return, the seller will remove the property from the market. The buyer’s deposit and the seller’s property are in escrow until the final exchange.

You must know that escrow “accounts” are more on your mortgage payment than your initial home purchase. You’ll have an escrow account when you borrow money from a bank or a direct mortgage lender. The lender will deposit part of your monthly mortgage payment in these escrow accounts. This will cover your taxes and insurance premiums. Furthermore, the escrow account decreases the risk of failing on your obligations to the government or your insurance provider. So, they should collect a part of those yearly expenses each month.

Key points:

  • Obtaining an escrow account is using a third party that holds an asset. Or funds before they are transferred from one party to another party.
  • The third-party handles the funds until the two parties have fulfilled their contractual requirements.
  • Escrow is often associated with real estate transactions. However, it can apply to any situation where funds pass from one party to another.

Understanding Escrow

Escrow is a process in which two different parties are in the process of completing a particular transaction. And this is also to ensure that the other party can fulfill their obligations. Specific contexts that use escrow include Internet transactions, banking, intellectual property, real estate, mergers and acquisitions, law, etc.

One example you may consider is a company selling its goods internationally. That specific company requires assurance that it will receive payment when the goods reach the buyer. The buyer, for their part, has to pay for the goods if they arrive in good condition. The buyer can place the money or funds in escrow with an agent with instructions to disburse the money to the seller. This is once the goods arrive in good condition. This way, both parties are secured, and the transaction can proceed.

What does an escrow account cover?

Your escrow account covers regular property taxes and homeowners insurance. They also cover flood insurance if you need it in your location. However, it does not cover water or sewer bills or one-time assessments by the federal government. It will also not cover homeowner association dues or supplemental tax bills.

Your escrow account covers regular property tax and homeowners insurance. Not to mention, it also covers flood insurance when required in your area. What it does not cover, however, are water bills, sewer bills, or one-time assessments made by your local government. It also does not cover homeowner association dues or any supplemental tax bills.

Establishing an escrow account at closing

When you close your loan, your lender will collect enough funds to make an escrow account. A part of your mortgage payment will go into your escrow account. And your lender will use those fees to pay your taxes and homeowners insurance bills when you need them. This will happen every month. This will continue for over 12 months, making your bank account easier. Also, it’s your lender who is making the payments. So you don’t have to feel stressed about remembering them every month.

When do you need an escrow account?

It depends on your kind of mortgage and your lender regarding needing an escrow account.

Government-backed loan options such as FHA and USDA loans need an escrow account. Lenders of other conventional loans can decide if you need an escrow account.

Having an escrow account is still a good idea, even though this is not necessary. You’ll be responsible for paying your property taxes and insurance if you don’t acquire an escrow account. You have to figure out how to handle budgeting. And also paying them on time when you don’t have an escrow account.

Your lender manages the payments and budgeting for you when you have an escrow account. Your taxes and insurance payments can be well managed for over a year. This is instead of paying the total amount all at the same time.

How do escrow accounts work?

When you acquire a mortgage loan from a bank or direct lender, you also obtain an escrow account to help you pay your property taxes. And you will also pay for your homeowners’ insurance premium at the right time. Although these are usually paid yearly, your lender will ask you to pay each monthly cost. And also, they will gather the balance in your escrow account. This is guaranteed that your expenses can get paid on time every year.

In addition, mortgage lenders will ask the borrower to have an escrow account. This is to lessen the risk of failing on your monthly financial obligations as a homeowner. Unpaid taxes or insurance can lead to charges. This will make it difficult for the mortgage lender to reclaim the original loan. This makes a strong incentive for lenders to have their borrowers on track with their escrow accounts that handle the non-mortgage expenses of owning a home.

More about escrow accounts

Escrow accounts also have some fallbacks for the borrower. This is even though they are convenient to pay the needed taxes and insurance premiums on your behalf. Lenders often ask you to keep a minimum balance in your escrow account. This is to safeguard you against any unexpected cost increases. They usually require a minimum of two months’ expenses on your mortgage escrow account. The limit can be higher, though, on riskier mortgages. Your lenders will review your escrow account once a year to ensure the calculated payments are on par with the costs.

More details on how escrow accounts work

An escrow account collects your payments for property taxes, homeowners insurance, and other items in equal amounts over a 12-month that they pay on your behalf when those bills are due. You can still handle these bills yourself if your lender agrees.

However, the choice is entirely up to your lender or, more likely, your investor that buys your loan. Your investors want to ensure that your bills are up to date, so they always require an escrow account. If you cannot pay your property taxes, this will result in a lien against the house. Furthermore, suppose your insurance is not current, and you suddenly have a fire that causes significant loss. In that case, there will be no protection from the expenses of renovating your property. This serves as the underlying collateral for your loan.

For new buyers, your lenders fund mortgages. However, they usually sell their loans to investors on the secondary market shortly after closing. These investors could be a different bank, a pension fund, or a foreign investment group. However, the person who ends up with your loan usually hires a third-party servicing company to collect the payments and disperse the funds. The term “lender” would also refer to your investors and servicers.

How can your escrow account pay for homeowners insurance?

Having an escrow account is like having a separate bank account you handle with your mortgage lender. This particular account can help you set aside monthly money for your bills for your property. And usually come due as a combined sum, such as your property taxes, homeowners insurance, and other bills like private mortgage insurance.

You make a single monthly payment that includes both your loan and escrow payments when you have an escrow account. Your escrow payment covers part of your property taxes, mortgage, and homeowners insurance. You may also earn interest on the balance in your escrow account.

Furthermore, your mortgage lender usually uses the fund in your account to pay those bills on your behalf when your taxes and homeowners insurance fall due.

Why escrow taxes and insurance fees?

Most people find it easiest to pay their taxes and insurance every month, so they use escrow accounts. In reality, it usually takes a highly disciplined person to remember to set aside money every month on their own so there’s enough money to pay their bills when they are due every year. If you’re not careful with your money, you’ll easily use it for other bills if it is just sitting in your desk drawer or the bank. Having an escrow account is like a kind of forced savings. This assures that your bills will be on time without penalty or late fees.

When your lenders require escrow accounts, the law limits the amount borrowers must pay. In general, the lender will divide the cost of your anticipated property tax by 12 and collect that much each month and your principal and interest payment. This will also cover the cost of your homeowners’ insurance and other items your escrow requires, like your homeowners’ association dues or flood insurance. If taken all together, these expenses will equal your payment to escrow.

How much money do you need in an escrow?

To get an idea of how much your monthly escrow payment will be, add up all these charges and divide by 12. For example, if your yearly tax bill is $2,000 and your insurance is $600 yearly, your escrow payment will be $216.67, or $2,600 divided by 12.

It’s also good to remember that the law allows lenders to maintain a “cushion” of no more than one-sixth of the total amount paid out of an escrow account. This is two months’ worth of payments, so your escrow account always has a balance. Also, note that your escrow payment could change yearly if your taxes or insurance expenses increase or the cushion amount needs adjusting.

All these things should happen automatically. You should still check your account from time to time since mistakes on your account can still happen. You’ll know something is wrong if you get a late notice from the county or your insurance company. However, fret not. The lender will pay all the penalties for failing to pay on time.

More about the amount of money in escrow

The law usually requires that you should have a complete breakdown within 45 days after making an escrow account showing the amounts you need to pay over the coming year. You must also have a free yearly statement that documents activity in the account. The statement should have what bills were paid and when to explain how much you must pay each of the next 12 months to keep your account current. 

When the loan is new, lenders usually low estimate the amount they collect for taxes and insurance since they can only estimate these expenses. It also makes your first payments more affordable. We suggest planning an increase in the escrow portion of your payment after the first 12 months.

How escrow analysis works

Your mortgage service will calculate the amount you must pay for your real estate tax and homeowners insurance bills. This is provided during closing and is based on the taxing authority, insurance company, and your previous taxes and insurance bills.

Your mortgage service will examine your account to ensure you’re paying the correct amount to maintain the minimum required balance. They have to do this every year. The amount can be overestimated or underestimated since it’s based on an estimate. This is what you call an escrow shortage or overage.

If there’s an overage, you’ll have a refund back into your account. Meanwhile, you’ll have several options to pay the remainder if there’s a shortage. The first option is to pay for the complete shortage upfront. The second option is to pay the shortage for a period of 12 months together with the regular payment. However, some service providers do not allow this. This depends on them.

How escrow works when buying a home

You’ll usually include a personal check of 1% to 2% of the purchase price when you offer a particular house. This is what you call “earnest money.” This shows the home seller that you’re a serious property buyer. In addition, the check won’t be deposited until the property seller accepts your offer.

You’ll have your money back in case your offer gets rejected. Meanwhile, the money will go into an escrow account if the offer is accepted. It will be held until it’s time to close the deal. Then, you can use the money for your downpayment and closing costs.

In this scenario, the escrow account acts as neutral, wherein your money is stored until all paperwork is done and your home is officially called yours.

How much do escrow fees cost?

The escrow agent will, of course, be needed to be paid a fee just like any other service provider. Escrow services for home purchases usually cost 1% to 2% of the final price. This is usually from $2,000 to $4,000, added to your other closing expenses. These are also negotiable between the buyer and seller, meaning that you can ask the other party to even all the escrow fees. This depends on local rules or current market conditions.

If you’re purchasing a property, you must deposit 1% to 3% of the final sale price in a joint escrow account with your seller. What you call “earnest money” proves that you’re serious about buying the sale and requires the seller to remove the property from the market when the transaction is finalized. When the transaction is complete, the earnest money you placed in your escrow account will go toward your down payment on the property. Earnest money in escrow is not a fee. However, be aware that it’s possible to forfeit that money if you fail to come to a final agreement with the seller.

What if you have an escrow shortfall or surplus?

Your lender will offer some options to make up the difference if your escrow has a shortfall in any given year. One example, you can pay the shortfall in full or via 12 equal payments over the following year so the deficit is made up by the next anniversary of your loan. In some cases, you may be offered a combination of the above. You could also pay some now and the rest for the next 12 months.

If your account has a surplus, the lender collected too much over the previous year. The lender will send you a check if a collection exceeds a certain amount. For smaller surpluses, the lender will apply it to next year’s escrow payments. If you’re given a choice, learn that what the lenders gave in one year will likely be taken away next year as a tax increase or higher insurance premiums.

When is escrow needed in a mortgage?

Escrow is essential in your initial home purchase and monthly mortgage payments. The escrow process assures both the buyer and seller. When both parties agree on a sale, a neutral third party, usually a bank, title company, and attorney will receive the signed purchase agreement. They act as escrow agents. They exist to monitor and fulfill the conditions of the sale, such as the buyer’s “earnest money” deposit for a certain percentage of the sale price.

Typical components of escrow in real estate


  • earnest money towards the down payment
  • proof of mortgage loan approval


  • access to the property for inspections
  • required repairs or renovations
  • inspection of title

When a property is already “in escrow,” the buyer and the seller will not receive anything from the escrow company until all the purchase agreement conditions are finalized. One example is you might agree to purchase an older property on one condition that the building passes a safety inspection. Other conditions include repairs and property tax audits. Furthermore, the buyer’s earnest money guarantees that the buyer has severe intent and can complete the purchase. The seller can forfeit this earnest money if the buyer backs out or fails to stay true to their contract.

One responsibility of escrow agents is to distribute money to parties other than the buyer and seller. These may be commissions to the real estate agent, prepaid mortgage interest to the lender, recording fees to the county office of records, and the escrow agent’s fees. Without an escrow account, you’ll be held responsible for sending on-time and accurate payments to every party involved in purchasing a property.

What are the pros of an escrow account?

First, having an escrow account helps you ensure you have enough monthly money to pay for yearly lump-sum expenses for your insurance and taxes. Second, your mortgage lender usually pays your insurance and property taxes. You’ll have to handle those payments if you don’t have an escrow account. However, checking your statements from your tax authorities and mortgage insurance company is still important to ensure your bills are paid correctly. Also, obtaining an escrow insurance account may give you peace of mind knowing that you have enough budget for some of your annual expenses of being a homeowner.

More benefits:

It’s automatic

One of the pros of having an escrow is it’s automatic. Having your mortgage lender holds your property tax and homeowners insurance payments in escrow guarantees that those bills will be paid on time and automatically. The good side is that you will avoid penalties such as late fees or potential liens against your home.

You’re covered when there are shortfalls.

Naturally, your homeowners’ insurance premiums and property tax assessments can fluctuate. For example, suppose your escrow account falls short due to your increasing property tax bill. In that case, your service will usually cover the difference temporarily and will increase your monthly mortgage payment to make it up.

No surprises in having an escrow account

Most of the time, you’ll know what to expect since the exact amount needed for your escrow account is added to your monthly mortgage payment. If the escrow component of your monthly mortgage payment needs to increase, you’ll get a written notice from your lender or servicer. Furthermore, your lender or servicer must send you a yearly escrow statement showing the amounts you have paid and any overages or shortages.

Potentially lower mortgage costs

You’ll get a discount on your interest rate or closing costs just by having an escrow account. This depends on your mortgage lender.

What are the cons of an escrow account?

Things that could not work for you

It’s automatic

Having your escrow account automatically is also a disadvantage for some. This feature can be a con for savers who can use the funds much better since your mortgage lender or servicer can collect the amount of your homeowners’ insurance and property tax payments, plus a monthly cushion in your escrow account.

You might miss out on short-term investment opportunities

At the same time, the money that could end up as an overage in an escrow account could be used for short-term investments. Instead of allowing a bank or lender to reap the gains, earning interest on such investments may make more financial sense.

A potentially large upfront payment

Making an escrow account often requires a homebuyer to deposit an amount equal to several months of property taxes and insurance premiums. These are “prepaid” and can add to your mortgage closing expenses.

It can be tough to get rid of

It can be hard to remove this account later if you change your mind once you already have an escrow account with your lender or servicer.

Can be targeted by scammers

Escrow accounts contain large amounts of money and can be attractive targets for scammers. Cyber thieves usually set up fake websites to phish for your personal information. They can get your name, bank account number, and credit card number. Some even go to lengths to set up fake phone lines to build your trust.

The bottom line on escrow accounts

Opening an escrow account is an essential part of purchasing a property. It may be required depending on the kind of loan you acquire. Having an escrow account can help you get peace of mind. Since they offer protection for you, this is a convenient solution for paying your taxes and insurance.

Maintaining a mortgage escrow account may or may not be required depending on your loan requirements. Most mortgage lenders allow homeowners like you to make property tax payments directly to the county assessor and homeowners insurance payments to their insurance provider. However, to have this option, they usually require a loan-to-value ratio below 80%, meaning you already made a down payment of at least 20% on your property.

In conclusion

Having an escrow account is familiar financial tool mortgage lenders and servicers use. This helps ensure that your responsibilities as a homeowner are met without much hardship. Your primary responsibility is making your mortgage payment. If escrow is not required, you may want to use alternative methods for your funds.

Ask us any questions.

Now that you have read about escrow accounts, please don’t hesitate to ask us any questions if you have something in mind, especially regarding homeowners’ insurance in Denver, CO. You may contact us via our phone numbers and email. Please also don’t hesitate to check our other blog entries about homeowners insurance. Have a great day!

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