Understanding Escrows: What They Are, How They Protect You, and Their Role in Homeownership

When you’re buying a home or making monthly mortgage payments, you’ll often deal with something called an escrow account. But what is an escrow account, and why do lenders use them?

In simple terms, it’s a neutral account used to hold money for property-related expenses like property taxes and homeowners insurance. Escrow protects both buyers and lenders by making sure key bills are paid on time.

For more information about escrow/impound accounts, see what the CFPB has to say.

Let’s break down how escrow works at different stages of homeownership — and how to manage it wisely.

Escrow During the Homebuying Process

Before closing on a home, buyers often make a good faith deposit known as earnest money. A neutral third party—like a title company—places this deposit into an escrow account, such as a title company or attorney.

This money proves you’re serious about purchasing the home. If the sale goes through, The lender applies it toward your down payment or closing costs. If the deal falls apart under certain conditions (like a failed inspection contingency), you’ll receive a refund of the deposit. Otherwise, the seller may keep it.

What Is an Escrow Account After You Buy?

Once you’ve purchased a home, your escrow account shifts purpose. Your mortgage lender now uses it to collect and pay recurring expenses like:

• Property taxes

• Homeowners insurance

• (Sometimes) Flood or mortgage insurance premiums

Each month, Your lender sets aside a portion of your mortgage payment in the escrow account. Because of this, when your bills are due, your lender pays them on your behalf.

Why Do Lenders Require Escrow Accounts?

Escrow accounts give lenders peace of mind. They help ensure that critical payments like taxes and insurance are made on time — reducing the risk of tax liens or policy lapses, which could jeopardize the home’s value.

Lenders usually require escrow if:

• You put less than 20% down

• You’re using certain loan types, like FHA or USDA

• You have lower credit scores or higher debt ratios

Pros and Cons of Using an Escrow Account

Pros:

• Simplified budgeting – One monthly payment covers everything

• Timely payments – Lenders ensure paying taxes and insurance on time

• Less risk – You’re not hit with large lump-sum bills

Cons:

• Higher monthly mortgage payment

• Escrow shortages or overages due to rising costs

• Less flexibility over how and when you pay

Can You Opt Out of an Escrow Account?

In some cases, yes. Borrowers with 20%+ equity, strong credit, and a history of on-time payments may qualify to waive escrow.

However, your lender may:

• Charge a fee or higher interest rate

• Require you to sign an escrow waiver agreement

• Ask for proof of paid taxes and insurance annually

Borrowers who waive escrow gain more control but must plan their finances carefully. Explore escrow waivers and when they make sense

How to Manage Your Escrow Account Effectively

To avoid surprises or miscalculations, follow these steps:

• Review annual escrow statements – Lenders send these each year with breakdowns

• Expect changes – Property taxes and insurance rates often increase

• Ask for an escrow analysis – If you’ve paid off a large balance or insurance premium, your lender may recalculate your payment

• Understand shortages – If your account falls short, the lender may raise your monthly payment or request a lump-sum deposit

Learn more: Managing your Escrow Account