If your mortgage lender pays your property taxes and homeowners insurance bill for you each year, you'll have an escrow payment attached to your regular mortgage payment. This means that you pay a little extra each month so that you don't have to worry throughout the year about saving the money needed to pay your property taxes and homeowners insurance.
Some mortgage lenders require their borrowers to create an escrow account. Other borrowers might simply elect to do this for the convenience. In an escrow arrangement, homeowners when making their monthly payments include an extra amount that lenders deposit into an interest-bearing account. Lenders then hold this money until homeowners' property taxes and insurance payments are due, when the lenders make the payments on behalf of their borrowers.
Each borrower's monthly escrow payments will vary according to their homeowners insurance premiums and property taxes. Borrowers who pay $1,000 each year for homeowners insurance and $5,000 each year in property taxes will need to pay $500 each month to their escrow account to cover these annual fees of $6,000.
Because neither homeowners insurance nor property taxes are fixed costs, the escrow payments -- and, because of this, the total mortgage payments -- of homeowners can change throughout the life of the loan. Borrowers' property taxes might rise if their municipalities need to fund a major road repair project or other capital project. Borrowers might see their homeowners insurance premiums jump if they renovate their kitchens or add a fourth bedroom to their home. When insurance or taxes rise, mortgage lenders need to request a larger escrow payment from their borrowers. When these fees fall, lenders might need to adjust borrowers' escrow payments in the opposite direction. In such cases, lenders must provide borrowers with written notice of any changes.
Homeowners who choose to create an escrow account do so because it's easier than saving up on their own for insurance and tax bills that can be significant. Instead of having to come up with a large lump-sum payment to pay these bills, homeowners can pay them gradually over time with each mortgage payment. For homeowners who aren't good planners, escrow accounts represent an easy way to make sure they are not short on cash for these payments.