What is an Escrow Account?


When you borrow money to buy a home, you may have to use an escrow account for monthly payments. Expenses like homeowners insurance
 and property taxes are often annual expenses, but most people think about monthly payments—and large annual bills catch them by surprise:

  • Smoothing expenses: To make those significant expenses more manageable, lenders often require that you save a portion of the annual amount each month. With each monthly payment, your funds go your loan balance (principal and interest) as well as your taxes and insurance. Those payments are often called PITI payments. With each monthly payment, the amount for your taxes and insurance goes into an escrow account until annual bills come due.
  • Required or optional? Some lenders require that you use an escrow account. Even if they don’t, you might decide to voluntarily use one to break your annual expenses into more manageable pieces. By spreading out the payments, you don’t have to scramble for funds when a significant bill comes in. Lenders often like to use escrow accounts because failing to pay taxes and insurance bills puts them at risk. If your house burns down, they want to get their money back, and taxing authorities may put a lien on your home (making it hard for you and the lender to sell).
  • Do it yourself? If you don’t have an escrow account to smooth out payments, plan ahead. Expect to pay property taxes once or twice per year, and decide how to pay for homeowners insurance. You may be able to pay monthly (on your own), or you might just choose to pay the full amount in a lump sum.
  • Best use of the money? You might worry that you can earn more on your savings than you get from an escrow account. That may be true, but evaluate the numbers with a critical eye. How much do you keep in your escrow account at any given time? Especially when interest rates are low, any extra earnings you might get at the bank of your choice won’t amount to much. Is it enough to move the needle on your finances?