What is an Escrow or Impound account?
What is an escrow account?
In the context of your mortgage, an escrow account is designated primarily for payment of your property taxes and homeowners insurance plus any other required insurance. You pay into the account, which is managed by your mortgage lender, as you make your mortgage payment.
It’s an easy way to help you budget for property tax and insurance bills. You don’t have to save for them separately or even make the payments yourself—you only have to worry about making your total monthly mortgage payment, which lumps these expenses in a consistent amount.
It can be a little confusing that the word “escrow” also shows up in the “title & escrow” services provided during your closing. This account is unrelated to those services.
How it works
1 – When you close on your home, you pay a starting balance for the escrow account. The amount is determined based on when your next property tax and insurance bills are due. This starting balance is often referred to as “reserves.”
2 – As part of your monthly mortgage payment (which typically starts about 30-60 days after your closing date) you will pay one twelfth of your total insurance and tax bills (so that the entire year gets covered evenly). This part of your monthly payment (also known as your “escrow payment”) gets deposited into the escrow account.
3 – When your property tax and insurance bills are due, the lender will pay them on your behalf out of this escrow account. There is always a cushion kept in this account (about 2 months’ worth) just in case your property tax and homeowners insurance bills rise in following years.
4 – According to the Real Estate Settlement Procedures Act of 1974 (RESPA), your lender is required to re-analyze your escrow account once a year to determine if they have been collecting the right amount. If ever your actual bills are lower than planned, you can expect a refund from your lender. If your actual bills are ever higher than anticipated, your lender will adjust your monthly escrow payment to help cover the shortage or allow you to pay the difference in a lump sum.
Reserves & your initial payment
Your initial payment into your escrow account, which is due at closing, is affected by the state where you’re buying a home because the payment will contribute to property tax—and property tax schedules vary state by state. Generally, the initial payment is determined by when your closing date falls relative to when your next property tax payment is due.
We’ll use the example of Washington state, where Flyhomes is headquartered. The graphic below shows how many months of reserves are needed at any given time in Washington state. Due to the timing of bill payments, different amounts of reserves are required during each month.
—In Colorado, property taxes are due twice per year in March and September. So, in those months you need 8 months of reserves—6 to pay the taxes and 2 as a cushion. Some of this initial deposit will be paid by the seller at your closing.
—No matter what state you live in, homeowners' insurance is due annually in the month you closed on your home. So, in that month (February in the graphic) you’ll need 14 months of reserves—12 to pay for insurance and 2 as a cushion.
Have more questions about escrow accounts, mortgage loans, or buying your first home in Colorado?
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