What Is Escrow? How It Works When You Buy a House

Escrow is an arrangement in which money or other items are held by a third party until specified conditions are met.

In real estate, buyers usually encounter escrow in two different ways.

During a home purchase, an escrow or settlement arrangement can hold money and documents while the transaction moves toward closing. After closing, a mortgage escrow account can collect part of your monthly payment so your servicer can pay expenses such as property taxes and homeowners insurance.

Those two uses serve different purposes, and understanding the distinction makes the rest of the closing process much easier to follow.

Key Takeaways

1. Purchase escrow helps hold money or documents until the conditions of a real estate transaction are satisfied.
2. A mortgage escrow account collects money for property taxes, homeowners insurance and certain other property expenses after closing.
3. Earnest money, a down payment and an escrow account are related parts of buying a home, but they are not the same thing.

What Is Escrow?

Escrow is a financial arrangement in which a neutral third party holds funds, documents or other property on behalf of other parties until agreed-upon conditions are satisfied.

In a real estate transaction, the term can refer to the settlement process used while a home is being purchased.

In mortgage servicing, an escrow account has a different meaning. Your lender or mortgage servicer can collect money with your monthly payment and use that account to pay certain property-related bills when they come due.

Purchase Escrow vs. a Mortgage Escrow Account

How Does Escrow Work When You’re Buying a House?

Escrow can begin shortly after the seller accepts your offer, depending on how closings are handled where you’re buying.

The purchase agreement establishes the obligations that must be satisfied before the transaction can close.

During that period, several things may be happening at the same time:

• You submit an earnest-money deposit.
• Your mortgage lender processes and underwrites the loan.
• The property is inspected.
• An appraisal or other valuation may be completed.
• Title work is performed.
• Insurance is arranged.
• Closing documents are prepared.
• Buyer and seller complete applicable contract requirements.

The settlement or escrow provider helps coordinate the money and documents needed to complete the transaction.

The exact process differs by state. A title company may handle settlement in one area, while an attorney or escrow company performs similar functions somewhere else.

Who Holds Earnest Money in Escrow?

That depends on the purchase agreement and local practice.

Earnest money may be held by a:

• Title company
• Escrow company
• Real estate brokerage
• Attorney
• Other authorized holder

The important point is that the deposit isn’t simply handed to the seller for unrestricted use while the purchase is pending.

It is handled according to the contract and applicable law until the transaction closes or the deposit must otherwise be distributed.

What Happens to Earnest Money at Closing?

If the purchase closes, your earnest-money deposit is generally credited toward the amount you owe in the transaction.

For example, suppose you need $45,000 at closing before accounting for your deposit and you’ve already provided $5,000 in earnest money.

That deposit would normally be accounted for when calculating the amount still due from you.

It isn’t an extra $5,000 expense on top of your down payment and closing costs.

What Happens to Earnest Money if the Deal Falls Apart?

It depends on the purchase agreement and why the transaction ended.

A contract can include contingencies involving issues such as:

• Financing
• Inspection
• Appraisal
• Title
• The sale of another property

If a buyer properly terminates the agreement under an applicable contingency, the contract may provide for the earnest money to be returned.

If the buyer breaches the agreement without a contractual basis to terminate, the seller may have a claim to some or all of the deposit, depending on the contract and applicable law.

Don’t assume that money held in escrow is automatically refundable simply because the purchase doesn’t close.

Escrow vs. Earnest Money vs. Down Payment

These terms are often mixed together, but they describe different things.

Your earnest money may be held in escrow and later credited toward the funds you need for closing.

Your down payment is part of the purchase price itself.

How Long Does Escrow Take When Buying a House?

There is no universal escrow period.

The timeline generally follows the period between the accepted purchase agreement and closing, so it can depend on:

• Your contract deadline
• Mortgage underwriting
• Appraisal timing
• Inspection negotiations
• Title work
• Insurance
• Buyer and seller readiness

One of the biggest variables for financed buyers is how long mortgage underwriting takes. A loan that needs several rounds of underwriting conditions can take longer to reach closing than a straightforward file.

The broader home closing process can also vary depending on the transaction and location.

What Can Delay Escrow?

Escrow or settlement can remain open longer when part of the transaction isn’t ready.

Potential delays include:

• Mortgage underwriting conditions
• A low appraisal
• Inspection or repair negotiations
• Title defects
• Unreleased liens
• Homeowners insurance problems
• Missing documents
• Buyer or seller scheduling issues
• Changes to the mortgage

A delay doesn’t necessarily mean the transaction is failing.

It means one or more requirements still need to be completed before the parties can close.

What Is a Mortgage Escrow Account?

A mortgage escrow account is an account your lender or servicer uses to collect money for certain property-related expenses.

A portion of your monthly mortgage payment goes into the account.

Your servicer then uses the money to pay eligible bills when they become due.

Common escrow expenses include:

• Property taxes
• Homeowners insurance
• Flood insurance when applicable
• Mortgage insurance in some circumstances
• Other eligible property-related charges

The Consumer Financial Protection Bureau notes that many lenders require borrowers to use escrow so taxes and insurance are paid when they’re due.

How Does Mortgage Escrow Affect Your Monthly Payment?

Your total mortgage payment can include more than principal and interest.

A simplified payment can look like:

Principal + interest + taxes + insurance + applicable mortgage insurance = total monthly housing payment

If property taxes and insurance are escrowed, your servicer collects the applicable amount with the monthly mortgage payment.

That means your total payment can change even if you have a fixed-rate mortgage.

Your principal-and-interest payment may stay fixed while taxes or homeowners insurance increase or decrease.

What Is an Initial Escrow Deposit?

When your mortgage escrow account is established, the lender may collect money at closing to begin funding it.

This amount appears in the closing-cost disclosures.

How much is needed depends partly on:

• When property taxes are due
• When insurance premiums are due
• Your closing date
• The expected annual bills

For many federally related mortgage loans covered by the Real Estate Settlement Procedures Act, federal rules limit how much a servicer can require for the escrow account.

The rules generally permit a cushion of no more than one-sixth of the estimated annual escrow disbursements, which is equivalent to about two months of those expenses.

You can see how initial escrow funding affects your broader purchase budget with a closing costs calculator.

What Is an Escrow Analysis?

Your servicer doesn’t simply keep collecting the same amount forever.

For covered mortgage escrow accounts, the servicer periodically analyzes the account to determine whether the amount being collected is appropriate for the expected bills.

The analysis looks at:

• Expected property-tax payments
• Insurance premiums
• Expected account balance
• Applicable escrow cushion
• Whether the account has a shortage, deficiency or surplus

For most federally related mortgage escrow accounts, the servicer provides an annual escrow account statement showing the account’s activity and projected amounts for the next year.

What Is an Escrow Shortage?

An escrow shortage means the account has less money than the target amount calculated by the servicer.

One common reason is that taxes or insurance cost more than previously estimated.

For example, suppose the servicer estimated that your annual homeowners insurance would cost $1,800, but the premium rises to $2,200.

The account has to cover the higher bill, and the lender may need to collect more money going forward.

That can increase your total monthly mortgage payment.

Can Your Mortgage Payment Increase Because of Escrow?

Yes.

A fixed-rate mortgage fixes the interest rate. It does not freeze your property taxes or homeowners insurance premiums.

If those costs increase, the amount you pay into escrow can increase too.

Your payment might also temporarily increase because an existing escrow shortage needs to be repaid.

Conversely, lower taxes or insurance expenses can sometimes reduce the escrow portion of your payment.

What Is an Escrow Surplus?

An escrow surplus occurs when the account contains more than the required target balance after the servicer performs its analysis.

For federally related mortgages subject to the applicable RESPA rule, a servicer generally must refund a surplus of at least $50 within 30 days after the analysis if the borrower is current.

A smaller surplus can generally be refunded or credited toward future escrow payments.

Who Pays Property Taxes and Insurance From Escrow?

Your mortgage servicer handles the payments when the applicable bills come due.

Federal mortgage-servicing rules generally require servicers to make required escrow disbursements on time when the borrower has been making the required escrow payments.

You should still review your mortgage statements, tax bills and insurance notices.

If you receive a notice saying a bill wasn’t paid, contact your mortgage servicer promptly rather than assuming it will resolve itself.

Do All Mortgages Require an Escrow Account?

No.

Escrow requirements depend on factors such as the mortgage program, loan characteristics and applicable law.

Some borrowers may be permitted to pay taxes and insurance directly instead.

Other loans require an escrow account.

For example, federal rules generally require escrow accounts for certain higher-priced mortgage loans secured by a first lien on a principal residence, subject to specified exceptions.

Your lender can tell you whether escrow is required for the mortgage you’re considering.

Can You Waive Escrow?

Sometimes.

The ability to waive a mortgage escrow account depends on the loan program, lender requirements, applicable law and characteristics of the transaction.

If an escrow waiver is available, the lender may have additional requirements or pricing associated with it.

Without an escrow account, you become responsible for budgeting and paying the applicable property-tax and insurance bills yourself.

That can mean paying large bills once or several times each year instead of spreading the cost across monthly mortgage payments.

Who Pays Escrow Fees When Buying a House?

The answer depends on what you mean by an escrow fee and where you’re buying.

A title, escrow or settlement company may charge a fee for handling the closing.

Who pays that fee can depend on:

• The purchase agreement
• State and local practice
• The settlement provider
• Negotiations between buyer and seller

There is no reliable national flat fee that applies to every transaction.

For a financed purchase, applicable settlement charges appear on your Loan Estimate and later on your Closing Disclosure.

Where Is Escrow on the Loan Estimate?

Escrow can appear in several places depending on what you’re looking for.

The Projected Payments section on Page 1 can show an estimated monthly escrow amount for applicable property expenses.

Page 2 can also show:

• Prepaid taxes and insurance
• Initial escrow deposits
• Applicable title or settlement fees

Don’t assume an escrow estimate is a lender fee.

Much of the money represents property taxes and insurance that you would still owe even if you paid those expenses directly.

Where Is Escrow on the Closing Disclosure?

The Closing Disclosure shows the final mortgage and settlement figures before closing.

You can use it to verify:

• Initial escrow funding
• Prepaid taxes and insurance
• Estimated monthly escrow payments
• Settlement charges
• Total closing costs
• Cash to close

Our Closing Disclosure walkthrough explains where those numbers appear across the five-page form.

What Is an Escrow Holdback?

An escrow holdback is money withheld at or after closing for a specific unresolved obligation.

For example, a transaction might use a holdback when agreed-upon work cannot be completed before closing.

But holdbacks aren’t simply an informal way for a buyer to reserve some of the seller’s money.

The mortgage lender, settlement provider, purchase agreement and applicable law can all affect whether a holdback is permitted and how it must be structured.

If repairs or post-closing occupancy are involved, make sure the agreement clearly addresses:

• How much money is held
• Who controls the funds
• What conditions release the money
• Deadlines
• How disputes are handled

When Does Purchase Escrow End?

Purchase escrow generally ends when the transaction is completed and the settlement provider can distribute the funds and documents according to the transaction requirements.

That can involve:

• Buyer signing required documents
• Seller signing required documents
• Lender providing mortgage funds
• Buyer providing required funds
• Title requirements being satisfied
• Required documents being recorded
• Funds being distributed to the appropriate parties

The precise sequence varies by location.

After that purchase escrow ends, a separate mortgage escrow account may continue for taxes and insurance.

When Does a Mortgage Escrow Account End?

A mortgage escrow account can continue as long as required by the mortgage, lender or applicable law.

If the loan is paid off, the servicer generally has to return the remaining escrow balance after the account is closed, subject to applicable requirements.

If you’re eligible to remove escrow before paying off the mortgage, the lender or servicer can explain the requirements.

Removing escrow doesn’t eliminate the underlying bills. You would become responsible for paying property taxes, homeowners insurance and other applicable expenses directly.

Is Escrow Good or Bad?

Escrow is primarily a mechanism for managing risk and payments rather than something inherently good or bad.

During a purchase, it allows funds and documents to be handled according to the transaction’s requirements instead of one party simply trusting the other to perform later.

After closing, a mortgage escrow account can make large tax and insurance bills easier to budget by spreading the expected cost across monthly payments.

The trade-off is that your monthly payment can change as those expenses change, and you have less direct control over when the individual bills are paid.

What Should You Check Before Closing?

1. Confirm who is holding your earnest-money deposit.
2. Know the deadlines and contingencies that affect your deposit.
3. Ask whether your mortgage requires an escrow account.
4. Review the estimated escrow payment on your Loan Estimate.
5. Check your prepaid taxes, insurance and initial escrow funding.
6. Review the final figures on your Closing Disclosure.
7. Verify your cash-to-close amount before sending funds.
8. Keep copies of your escrow and closing documents after the purchase.

Bottom Line

Escrow can describe two different parts of homeownership.

During a purchase, a neutral settlement arrangement can hold money and documents while the parties complete the requirements for closing. Your earnest-money deposit is often part of that process.

After closing, a mortgage escrow account can collect money each month so your servicer can pay expenses such as property taxes and homeowners insurance.

The two systems are separate, but both are designed to make sure money is available and distributed when specified requirements are met.

Understanding the distinction will also make your Loan Estimate, Closing Disclosure and monthly mortgage statement easier to read.

FAQ

What is escrow in real estate?

Escrow is an arrangement in which a third party holds funds, documents or other property until specified conditions are satisfied. Buyers can encounter escrow during the purchase and through a mortgage escrow account after closing.

What is an escrow account on a mortgage?

It is an account managed by your mortgage servicer that collects money for eligible property expenses such as property taxes and homeowners insurance.

Is earnest money the same as escrow?

No. Earnest money is a deposit connected with the purchase agreement. Escrow is the arrangement through which that money may be held until it is distributed according to the contract.

Is escrow the same as a down payment?

No. Your down payment is the portion of the purchase price you pay instead of borrowing. A mortgage escrow account generally holds money for future property-related expenses such as taxes and insurance.

Does escrow count toward closing costs?

Initial escrow funding can be part of the amount collected at closing and appears in the closing-cost disclosures, but it is different from a lender fee. The money is being reserved for applicable future property expenses.

Why did my escrow payment increase?

Property taxes or insurance premiums may have increased, or the account may have an escrow shortage that needs to be addressed. Review your annual escrow analysis for the specific reason.

What is an escrow shortage?

An escrow shortage occurs when the account balance is below the target amount calculated by the servicer. Higher taxes or insurance premiums are common causes.

What is an escrow surplus?

A surplus means the escrow account contains more than its calculated target balance. Federal rules govern how servicers must handle qualifying surpluses on covered mortgages.

Can you buy a house without escrow?

You may be able to complete a transaction without a long-term mortgage escrow account depending on the loan and lender requirements. However, settlement arrangements for handling deposits and closing funds are a separate issue.

Can you remove escrow from a mortgage?

Sometimes. Eligibility depends on the mortgage, lender, loan program and applicable rules. Removing escrow means you become responsible for paying applicable taxes and insurance directly.

Who holds escrow during a home purchase?

Depending on the location and transaction, funds may be held by a title company, escrow company, attorney, brokerage or another authorized settlement provider.

How long does escrow take?

For a purchase, escrow generally follows the transaction’s contract-to-closing timeline. Mortgage underwriting, appraisal, title work, inspections and other requirements can affect how long the process takes.