What is an escrow account?

An escrow account is a convenient way of managing your property taxes, insurance, and other expenses.

What Is An Escrow Account?

Depending on the type of mortgage you have, you may be required to have an escrow account, or you may choose to have one for convenience. An escrow account is simply a separate account that you fund and your mortgage company uses to make property tax, homeowners insurance, and mortgage insurance payments (if applicable) on your behalf. Other items, such as flood or fire insurance, may also be paid out of this account.

Here’s how it works: A portion of your total monthly payment goes toward the mortgage to pay the principal and interest. The other portion of your payment goes into an escrow account to pay your property taxes, insurance, and other escrowed items. When these bills are due, your mortgage company withdraws funds from your escrow account and pays the bills on your behalf. If your mortgage is transferred to a new servicer, the escrow account usually goes with it. If not, the remaining balance is refunded.

Escrow accounts are convenient. They are an easy way to ensure that your property-related bills are paid when they are due, without you having to keep track of due dates or having to plan separately to make lump-sum payments throughout the year. Because a portion of the funds needed for your escrowed items is collected with each monthly mortgage payment, sufficient money is set aside for when these bills become due.

Changes in taxes and insurance premiums are common. To help cover potential increases in your bills, Wells Fargo may require that you maintain a minimum balance in your escrow account. We will review your account each year to make sure enough is being collected to cover your escrow-related bills. If your bills are projected to change, then your monthly escrow deposit and minimum balance amount will be adjusted accordingly.

If the review determines that your escrow account holds more than the minimum balance required, this is called an overage. This can happen if the bills paid from your escrow account were lower than expected in the previous year, or are projected to be lower in the coming year. If you have an escrow overage and your mortgage account is current, you will receive a refund for the overage amount.

If the funds in your escrow account fall below the minimum balance required, this is called a shortage. This happens if the bills paid from your escrow account were higher than expected in the previous year, or are estimated to be higher in the coming year. To make up for a shortage, you can choose to pay the entire amount all at once or spread it evenly over 12 monthly payments. Either way, you can pay back the shortage without being charged fees, interest or surcharges.

After each yearly escrow review, we will send you an escrow review statement that shows any changes to your escrow account and your new total monthly payment amount.

Learn More: The Components of a Mortgage Payment

A mortgage payment is typically made up of four components: principal, interest, taxes and insurance.

The Principal portion is the amount that pays down your outstanding loan amount.

Interest is the cost of borrowing money. The amount of interest you pay is determined by your interest rate and your loan balance.

Taxes are the property assessments collected by your local government. Lenders typically collect a portion of these taxes in every mortgage payment and hold the funds in an account, called an escrow account, until they are due.

Insurance offers financial protection from risk. Like property taxes, homeowners insurance payments are typically held in an escrow account, and then paid on your behalf to the insurance company.

Two main types of insurance can be included as part of your mortgage payment.

Homeowners insurance is required financial protection you must maintain in case your property is damaged by fire, wind, theft, or other hazards. Depending on your geographic location, you may be required to get additional flood insurance.

Mortgage insurance protects your lender in case you fail to repay your mortgage. Whether or not mortgage insurance is required usually depends on the size of your down payment and other circumstances.

In the early stages of your mortgage term, only a small portion of your monthly payment will go toward repaying your original principal.

As you continue to make payments through the years, a greater portion will go to reducing the principal.

When you understand the components of your mortgage, how they change over time, and how they can affect equity, you are in a better position to manage it.