What Is an Escrow Balance?

You recently bought a home and your first mortgage statement arrives. There's a line item called "escrow balance" with a number that doesn't quite make sense. You expected to see your loan principal and interest, but now there's this extra account holding thousands of dollars of your money. It's your mortgage escrow account.

Mortgage escrow exists to cover your property taxes and insurance, but it sometimes can be confusing to understand. In this guide, we'll walk you through how escrow balances work, what causes them to change, and how to handle escrow shortages or surpluses.

What Does 'Escrow Balance' Mean?

An escrow balance is the amount of money currently in your escrow account. When you make your monthly mortgage payment, a portion goes toward your loan principal and interest, and another portion gets deposited into this separate account that your lender manages.

Your lender uses the funds in this account to pay your property taxes and homeowners insurance on your behalf when those bills come due. The balance fluctuates throughout the year as you make deposits and your lender makes disbursements to cover your bills.

How Is Your Escrow Balance Determined?

Lenders calculate your escrow balance by estimating your annual property taxes and insurance premiums, then dividing that total by 12 to figure out how much you'll contribute with each monthly payment. They also add a cushion to make sure there's always enough money in the account to cover bills when they're due, even if costs increase slightly.

Under the Real Estate Settlement Procedures Act (RESPA), lenders can require a maximum cushion equal to two months' worth of escrow payments. Your monthly payments include this escrow portion along with your principal and interest, building up the balance over time so funds are available when your bills arrive. The reason is that lenders are required to pay your annual insurance and taxes when due, regardless if the amount of money in your escrow account covers the payments.

Why Does an Escrow Balance Change?

Your escrow balance shifts as your lender collects funds and pays your bills. A few factors cause your balance to fluctuate beyond the normal deposit and escrow disbursement cycle:

• Property tax reassessments after purchase: When your local tax assessor reassesses your property, your real estate taxes can go up or down. Your lender adjusts your monthly escrow contribution to match the new amount.
• Insurance premium changes: If your insurance premiums increase, your escrow balance needs to increase, too. Your lender recalculates what you owe each month to cover the higher cost.
• New construction and first-year estimates: Escrow for new homes starts with estimated taxes since the property hasn't been fully assessed yet. Once the county completes its assessment, you may get a supplemental tax bill that makes your escrow balance and monthly payment jump.

If you're checking your current escrow balance and notice it's changed from last month, one of these factors is likely the reason.

Understanding an Escrow Analysis

An escrow analysis is a review your lender does once a year to compare what you've paid into escrow against what they've actually spent on your taxes and insurance. The lender checks whether they've collected too much or too little and adjusts your future monthly payments.

You'll receive the results in a notice separate from your regular mortgage statement, typically showing your new payment amount and explaining any shortage or surplus.

What Happens When Your Escrow Balance Changes?

Your escrow balance changes every month. It goes down when bills get paid and goes back up with each mortgage payment you make. Your payment amount only changes when your lender's annual analysis shows a shortage or surplus, which happens when your tax or insurance costs change.

If your escrow balance is off, your lender will notify you. You can review your escrow statement to verify that the numbers match your tax and insurance bills. If you spot an error or expect a major change in your property taxes or insurance costs, it's best to contact your lender to request a review rather than waiting for the annual analysis.

How To Pay an Escrow Shortage

An escrow shortage is your responsibility to cover, and your lender will give you options for how to pay it. You can typically pay the full shortage as a lump sum by a deadline specified in your escrow analysis statement, which immediately brings your account back to the required balance. If paying all at once isn't feasible, you can spread the shortage across your monthly mortgage payments over the next 12 months, but this will increase your payment amount.

How To Handle an Escrow Surplus

Your lender handles the surplus refund after completing the annual escrow analysis. If your balance is more than $50 over the required amount, RESPA rules require the lender to send you a refund check within 30 days.

If the surplus is under $50, your lender applies it to next year's escrow payments, which lowers your monthly payment.

When To Request an Escrow Review

You can request an escrow review anytime you see an error in your account or when your property taxes or insurance costs change mid-year. This is called an off-cycle review since it happens outside your lender's regular annual analysis schedule.

Contact your lender's escrow or customer service department with documentation of the change, such as your updated tax bill or insurance policy, and they'll recalculate your required balance and monthly payment.

Final Thoughts: Understanding Your Escrow Balance

Your escrow balance simplifies homeownership by ensuring your property taxes and insurance get paid on time. It'll fluctuate as payments go in and out, but your monthly contribution only changes when costs shift and your annual analysis shows a shortage or surplus.

Freedom Mortgage provides loan options that give you potential money-saving flexibility with how you manage escrow. If you're ready to take the next step toward homeownership, get prequalified today to see what you can afford.