Escrow is one of those words that comes up constantly in homebuying — and rarely gets explained. It actually refers to two different things depending on where you are in the process: closing escrow (a temporary account that holds funds during a real estate transaction) and mortgage escrow (an ongoing account your lender uses to pay your property taxes and insurance).
Both protect everyone involved. Here’s how each one works.
Escrow During the Homebuying Process
When a buyer and seller reach an agreement on a home sale, neither side hands money directly to the other. Instead, funds go into an escrow account held by a neutral third party — usually a title company or escrow company — until all conditions of the sale are met.
This protects both parties:
- The buyer knows their earnest money deposit won’t go to the seller until the home passes inspection, the title is clear, and the mortgage is approved.
- The seller knows the buyer has committed real money and the deal is moving forward.
When all conditions are satisfied, the escrow company releases the funds, records the deed, and the sale completes. This is called “closing escrow” or simply “closing.”
What Goes Into Escrow at Closing
At closing, the buyer’s funds flow through escrow to cover:
- The down payment
- Closing costs (lender fees, title insurance, recording fees, prepaid interest)
- Prepaid property taxes and homeowners insurance (typically 2–3 months upfront)
- Any seller credits or adjustments
The escrow company acts as a settlement agent — it collects all money, pays all parties (seller, lender, real estate agents, title company), and records the transaction with the county. You’ll receive a Closing Disclosure before closing that itemizes every dollar.
Earnest Money and Escrow
When you make an offer on a home, you typically submit earnest money — usually 1–3% of the purchase price — as a deposit. This goes into the escrow account right away, not to the seller.
If the sale closes, your earnest money is applied toward your down payment or closing costs. If the sale falls through due to a contingency (like a failed inspection or inability to get financing), you generally get it back. If you back out for reasons not covered by a contingency, the seller may keep it.
Mortgage Escrow: The Ongoing Account
After you close on a home, your lender will likely set up a mortgage escrow account — a separate account within your loan where a portion of each monthly payment is deposited to cover property taxes and homeowners insurance.
Instead of saving those large bills yourself and paying them annually, your lender:
- Collects a monthly amount from you (added to your mortgage payment)
- Holds it in the escrow account
- Pays your property tax bill and insurance premium directly when they’re due
This ensures those obligations are never missed — which protects the lender’s interest in the property. It also protects homeowners who might struggle to set aside money for large irregular expenses.
How the Escrow Payment Is Calculated
Your lender estimates what your property taxes and insurance will cost for the year, then divides by 12. That amount is added to your principal and interest payment.
Example: If your annual property tax is $3,600 and your homeowners insurance is $1,200, that’s $4,800/year — or $400/month added to your payment.
Lenders also keep a cushion (usually 1–2 months of estimated payments) in the account to cover any unexpected increases.
Escrow Analysis and Adjustments
Once a year, your lender performs an escrow analysis — comparing what was collected to what was actually paid out. If taxes or insurance went up, you may face a shortage, which means:
- A lump-sum payment to cover the gap, or
- A higher monthly escrow payment going forward
If there was a surplus (you paid in more than needed), you’ll receive a refund check. This is why your mortgage payment can change slightly from year to year even on a fixed-rate loan.
Can You Opt Out of Escrow?
Some lenders allow borrowers to waive the escrow account — typically if you put down 20% or more and have strong credit. Without escrow, you’re responsible for paying property taxes and insurance directly on your own schedule.
This requires financial discipline. Missing a property tax payment can result in penalties or, eventually, a tax lien on your home. Missing an insurance payment can lapse your coverage — leaving your lender to force-place insurance (which is much more expensive) and bill you for it.
Most first-time buyers are better served by keeping the escrow account in place.
Escrow on a Refinance
When you refinance, you go through a closing process similar to your original purchase. Your existing escrow account is closed and funds are returned to you (usually within 30 days). A new escrow account is set up with your new lender.
At the refinance closing, you’ll prepay the first few months of taxes and insurance into the new escrow account — which is why refinancing involves upfront costs even if you’re rolling the closing costs into the loan.
Key Escrow Terms
- Escrow account: A third-party account holding funds during a transaction or managing ongoing tax/insurance payments
- Earnest money: Deposit held in escrow when an offer is accepted
- Closing escrow: The process of completing a real estate sale through an escrow company
- Escrow analysis: Annual review by your lender comparing escrow collections to actual disbursements
- Escrow shortage: When taxes or insurance rose and the account didn’t collect enough
- Escrow surplus: When more was collected than needed — results in a refund
- Impound account: Another name for a mortgage escrow account, used in some states