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Mortgage Escrow Explained: How It Works, When It Changes, and What to Watch

A practical guide to mortgage escrow accounts: how they work, why your payment can increase unexpectedly, and how to estimate escrow changes accurately.

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Ahmet C. Toplutaş

12/15/2025

15 min read

Escrow accounts are one of the most misunderstood parts of homeownership. Your lender collects extra money each month to pay property taxes and insurance, but when those costs increase, your monthly payment jumps unexpectedly. This guide explains how escrow works, why shortages happen, and how to estimate changes so you're not surprised.

1) What escrow is (and why lenders require it)

An escrow account is a separate account your lender maintains to pay property taxes and homeowners insurance on your behalf. Instead of you paying these bills directly (usually twice yearly), you pay 1/12th of the annual amount each month as part of your mortgage payment. The lender then pays the bills when they're due. Lenders require escrow for loans with less than 20% down payment, and many require it for all loans to ensure taxes and insurance are paid on time (protecting their collateral).

2) How escrow is calculated (the cushion rule)

Your monthly escrow payment is calculated as: (Annual Taxes + Annual Insurance) / 12, plus a cushion. Federal law allows lenders to collect up to 2 months' worth of escrow payments as a cushion (buffer for increases). So if your annual taxes are $6,000 and insurance is $1,800, your monthly escrow is ($6,000 + $1,800) / 12 = $650, but the lender might collect $650 + (2 × $650 / 12) = $758/month to build the cushion. This cushion is returned to you if you pay off the loan or if it's not needed.

3) Why escrow payments increase (the shortage problem)

Escrow payments increase when property taxes or insurance premiums rise. If your lender underestimated these costs, you'll face an escrow shortage. For example, if your lender estimated $6,000/year in taxes but they're actually $7,200, you have a $1,200 shortage. The lender will increase your monthly payment to: (1) cover the shortfall, and (2) build a new cushion based on the higher amount. This can add $100-300/month to your payment unexpectedly.

4) Property tax reassessments (the big jump)

After you buy a home, the property is often reassessed at the purchase price. If the previous owner bought it for $300,000 but you paid $400,000, your taxes will jump significantly. In many areas, this can mean a $2,000-4,000 annual increase, adding $200-400/month to your escrow payment. This usually happens 6-18 months after purchase, so budget for it.

5) How to estimate escrow changes

To estimate future escrow changes: (1) Check your property's current tax assessment and recent increases (usually 2-5% per year in most areas). (2) Get actual insurance quotes, not estimates—rates can vary significantly. (3) Factor in reassessment if you recently bought. (4) Add 2 months' cushion to the new annual total, then divide by 12. This gives you a realistic monthly escrow estimate.

6) Escrow analysis and refunds

Lenders perform an escrow analysis annually. If you've overpaid (cushion is too large or costs decreased), you'll get a refund and your payment will decrease. If you've underpaid (shortage), your payment increases. You can request an escrow analysis anytime if you think there's an error. Keep your own records of tax and insurance payments to verify the lender's calculations.

❓Escrow FAQ

Can I avoid escrow?

If you put 20% or more down, some lenders allow you to pay taxes and insurance directly. However, you must be disciplined—miss a payment and the lender may force you into escrow. For most borrowers, escrow is simpler and safer.

What happens to escrow when I refinance?

Your old lender refunds any escrow balance to you (usually within 30 days). Your new lender will set up a new escrow account and collect the initial deposit plus monthly payments. You may need to pay the first year's taxes/insurance upfront at closing.

Can I get my escrow cushion back?

The cushion stays in the account while you have the loan. If you pay off the loan or refinance, the lender returns any excess escrow balance (usually within 30 days).

What if I disagree with the escrow analysis?

You can request a detailed escrow analysis statement and challenge errors. Common issues include: incorrect tax amounts, double-counting insurance, or miscalculating the cushion. Contact your lender's escrow department with documentation.

Key Takeaways

Escrow accounts are designed to protect both you and the lender, but they can cause payment surprises when taxes or insurance increase. The key is to anticipate these changes: check property tax trends in your area, get actual insurance quotes (not estimates), and budget for reassessment after purchase. Use the mortgage calculator to see how escrow changes affect your total payment, and keep your own records to verify the lender's calculations.

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