The two kinds of escrow
The word "escrow" gets used for two different things in homebuying. Knowing which one is being talked about clears up most of the confusion.
1. Escrow during the purchase
From the time your offer is accepted until closing, you and the seller are "in escrow." A neutral third party (the escrow or title company) holds your earnest money deposit, coordinates document signing, and ensures the funds and the title transfer happen at the same moment.
This kind of escrow exists because no one trusts anyone enough to do a $500,000 transaction face-to-face on a single afternoon. The escrow company makes sure the buyer's money and the seller's deed get exchanged simultaneously, with no party able to walk away with both.
2. The mortgage escrow account
Once you close, your monthly mortgage payment includes more than just principal and interest. Most loans also collect 1/12 of your annual property taxes and homeowner's insurance with each payment. The lender holds those funds in an escrow account and pays the tax bill and insurance premium when they come due.
This is required on most FHA, VA, and USDA loans, and on conventional loans with less than 20% down. On conventional loans with 20%+ down, it's typically optional.
Why escrow accounts exist
From the lender's perspective, the property securing the loan needs to stay insured and tax-free. If you stop paying property taxes, the county can put a lien on the home that supersedes the mortgage. If you stop paying insurance, a fire could wipe out the lender's collateral.
By collecting taxes and insurance with the mortgage payment, the lender knows those bills get paid. From the homeowner's perspective, it's a forced savings plan — you don't have to remember to set aside money for tax bills.
Escrow shortages and surpluses
Property taxes and insurance change year to year. Once a year, your lender does an escrow analysis: did we collect enough, too much, or about right?
- Surplus: You get a refund check.
- Shortage: Your monthly payment goes up to make up the gap, sometimes with a one-time catch-up payment.
Tax increases are the most common reason for escrow shortages. Insurance premium hikes are second. If you see your mortgage payment jump unexpectedly, an escrow analysis is usually the cause — the principal-and-interest portion is fixed.
Have specific questions?
Escrow gets confusing fast. Reach out and we'll walk through your specific scenario.