Escrow: What It Is, How It Works, and Why It Matters

If you’re buying a home, refinancing, or already own one, you’re going to encounter escrow. It’s a foundational part of how real estate transactions and mortgage payments work in the United States, yet it’s also one of the least clearly explained concepts borrowers deal with.

Escrow isn’t complicated, but it is procedural. When people are confused by escrow, it’s usually not because the concept is hard—it’s because no one took the time to explain when escrow is used, who controls it at different stages, and why your payment can change even when your interest rate does not.

This guide walks through escrow the same way lenders and servicers actually use it: first during the purchase, then over the life of the loan, and finally how and when it can change.

What is Escrow?

Escrow is a third‑party arrangement where money or documents are held until specific conditions are met. The party holding the escrow is neutral. They do not represent the buyer or the seller exclusively, and they do not release funds until the terms of the agreement are satisfied.

In residential real estate, escrow is used in two distinct ways:

Escrow is used during the home‑buying process to hold earnest money and other funds until closing. After closing, escrow is commonly used as part of your mortgage payment to collect and pay property taxes and homeowners insurance.

The word is the same, but the function is different depending on the stage of ownership.

Escrow During the Home Buying Process

When you make an offer on a home, the contract typically requires an earnest money deposit. This deposit demonstrates intent to purchase and is part of what makes an offer credible to a seller.

That money is not paid directly to the seller. Instead, it is placed into an escrow account managed by a title company or escrow agent. The funds remain there until the transaction either closes or terminates under the terms of the contract.

If the sale closes, the earnest money is credited toward your down payment or closing costs. If the transaction is terminated for a contractually allowed reason—such as inspection issues, financing denial, or appraisal problems—the earnest money is returned to the buyer. If the buyer defaults outside of those terms, the seller may be entitled to the deposit.

Austin Homebuyer Example

A buyer purchasing a home in Austin submits a $20,000 earnest money deposit. During the inspection period, structural issues are identified that materially affect the property. Because the purchase agreement allows termination based on inspection findings, the buyer exits the contract. The escrow agent releases the earnest money back to the buyer according to the contract terms.

Escrow ensures the funds are handled objectively. Neither party controls the money while contingencies are being resolved.

Escrow Holdbacks After Closing

Escrow does not always end on closing day. In some transactions, a portion of funds remains in escrow temporarily after the sale is complete. This is referred to as an escrow holdback.

Holdbacks are commonly used when agreed‑upon repairs have not been completed, when final utility bills or municipal charges are outstanding, or when a seller remains in the home for a short period after closing. In new construction, escrow funds may remain in place until the buyer confirms that the home has been completed according to contract.

Once the conditions of the holdback are satisfied, the escrow agent releases the funds to the appropriate party.

Escrow for Property Taxes and Homeowners Insurance

After closing, escrow most commonly refers to the account your mortgage servicer uses to manage property taxes and homeowners insurance.

Each month, a portion of your mortgage payment is allocated to escrow. Those funds are held by the servicer until your tax bill or insurance premium is due, at which point the servicer pays those expenses on your behalf.

Some states refer to this as an impound account. Regardless of the name, the purpose is the same: ensuring that critical property‑related expenses are paid on time.

Stamford, Connecticut Example

A homeowner in Stamford purchases a $900,000 property. Annual property taxes total approximately $18,000, and homeowners insurance is $2,400 per year. Rather than paying these costs in lump sums, the servicer collects roughly $1,700 per month through escrow and pays the city and insurance carrier when the bills come due.

This structure reduces the risk of missed payments and smooths cash flow throughout the year.

How Escrow Payments Are Calculated

Escrow amounts are based on actual expenses, not estimates pulled from thin air.

Each year, your servicer reviews what was paid for property taxes and insurance during the prior year. They project what will be required for the upcoming year and divide that total into twelve monthly payments. Most lenders also require a reserve cushion, typically up to two months of escrow payments, to protect against shortfalls.

Because property taxes and insurance premiums can change annually, escrow is recalculated every year.

Escrow Analysis: Shortages and Surpluses

Your servicer performs an escrow analysis annually.

If the account has more money than required, you receive an escrow refund and your monthly payment may decrease. If the account has collected less than needed, a shortage exists.

When a shortage occurs, borrowers are usually given options. The shortage can be paid in a lump sum or spread out over the following year by increasing the monthly escrow portion of the mortgage payment.

Example: Escrow Shortage

A homeowner in Austin, Texas buys a property for $650,000. The initial escrow estimate is based on the seller’s lower assessed tax value. After purchase, Travis County reassesses the home at the new sales price, increasing annual property taxes by $3,600. When the servicer performs the escrow analysis, the account is short. The borrower is given the choice to either pay the $3,600 shortage upfront or spread it out over the next year, increasing the monthly payment by $300.

Example: Escrow Surplus

A homeowner in San Antonio, Texas sees homeowners insurance premiums decrease after switching carriers midyear. Because the servicer had already been collecting escrow based on the prior, higher premium, the account ends the year with excess funds. During the annual escrow analysis, the servicer issues a refund for the surplus and reduces the borrower’s monthly escrow payment going forward.

This is one of the most common reasons homeowners see payment changes despite having a fixed interest rate.

Who Manages the Escrow Account?

During the purchase, escrow is typically managed by a title company or escrow agent. They hold earnest money, manage documents, and ensure funds are distributed correctly at closing.

After closing, escrow is managed by the mortgage servicer. The servicer collects payments, maintains records, and pays property taxes and insurance premiums when due. The servicer may or may not be the same company that originated the loan.

If you change insurance providers, it is your responsibility to notify the servicer to ensure uninterrupted coverage.

Do you NEED an Escrow Account?

Lenders have a financial interest in making sure property taxes and homeowners insurance are paid consistently and on time.

Unpaid property taxes can result in tax liens that take priority over the mortgage. Lapsed insurance can expose the property to catastrophic loss with no coverage in place. Escrow reduces both risks by ensuring those obligations are handled automatically.

For borrowers, escrow also reduces administrative burden and the risk of missed payments by spreading large, irregular expenses into predictable monthly amounts.

That said, escrow is not mandatory for every borrower.

Some borrowers—typically those with strong credit profiles, low debt‑to‑income ratios, and sufficient equity—may be eligible to waive escrow entirely. In certain cases, this can be done at no cost and without any impact to the interest rate.

Other borrowers may still be allowed to waive escrow, but doing so can come with trade‑offs. Some lenders charge an escrow waiver fee at closing, while others offset the additional risk by slightly increasing the mortgage interest rate.

Finally, some borrowers simply do not have the option to waive escrow at all. Many loan programs require escrow regardless of credit strength or equity position, particularly when down payments are smaller or the loan carries higher overall risk.

Potential Drawbacks of Escrow

Escrow increases your monthly payment because you are paying property taxes and homeowners insurance gradually instead of in one or two large lump sums each year. While this smooths cash flow, it can make the monthly mortgage payment feel higher than expected—particularly for first‑time homeowners who are comparing their payment to rent or to a principal‑and‑interest quote alone.

In the first year of ownership, escrow estimates can also be imperfect. When a property is reassessed after purchase, property taxes often rise to reflect the new sales price. If the original escrow estimate was based on the seller’s lower assessed value, the account may come up short. When that happens, the borrower is responsible for covering the shortage, either through a one‑time payment or through higher monthly escrow payments the following year.

Escrow surpluses can be frustrating as well. If too much money is collected, the excess funds remain in the escrow account until the annual escrow analysis is completed. Borrowers cannot simply request a withdrawal at will. Federal rules limit how much a servicer can hold and when surplus funds must be returned, but refunds are generally issued only after the formal review—not on demand.

This can be particularly irritating for borrowers who maintain strong cash reserves and would prefer to control that money themselves. Even though surplus funds ultimately belong to the homeowner, they are temporarily tied up in the escrow account and unavailable for other uses until the servicer releases them.

While payment adjustments—whether due to shortages or surpluses—can feel abrupt, they reflect changes in tax assessments or insurance premiums rather than changes to the loan itself. The underlying mortgage terms remain the same; escrow is simply adjusting to real‑world costs.

What Escrow Does Not Cover

Escrow accounts are limited to specific expenses. Utilities, HOA dues, maintenance, repairs, and special assessments are not paid through escrow. Supplemental tax bills are also typically excluded. These costs are the homeowner’s responsibility to budget for separately and often catch new homeowners off guard because they fall outside the monthly mortgage payment. Escrow is designed to handle predictable, recurring obligations—not variable or one‑off expenses tied to how a property is used or maintained.

Removing Escrow From an Existing Mortgage

In some cases, escrow can be removed after closing. Lenders typically require a loan‑to‑value ratio of eighty percent or less, a strong payment history, proof of active homeowners insurance, and a positive escrow balance. Certain loan programs do not permit escrow removal at all, regardless of credit strength or equity.

We see many homeowners—particularly those who refinance once they have built meaningful equity—choose to remove escrow as part of that refinance. For these borrowers, the goal is often simplicity and control: paying taxes and insurance directly, avoiding annual escrow analyses, and eliminating the risk of unexpected payment changes tied to reassessments or insurance increases.

Removing escrow should be a deliberate financial decision rather than a reaction to a payment increase. Borrowers who opt out need to be comfortable setting aside funds on their own and managing large, infrequent bills without relying on a servicer to do it for them.

The Bottom Line

Escrow is a structural part of how residential mortgages function. It protects buyers and sellers during a transaction and ensures that critical property expenses are paid throughout the life of the loan.

Understanding escrow won’t make your mortgage more exciting, but it will make it more predictable—and that is the point. Schedule a call with me today or get in touch with me by completing this quick form to discuss your homebuying or refinancing options.