Escrow Account

An escrow account is money a lender or servicer holds for the borrower to pay bills tied to the loan, most often property taxes and hazard insurance. Each month, the borrower pays an extra amount on top of principal and interest, and the servicer pays the bills when they come due.

This protects the collateral. Unpaid taxes can lead to a tax lien that ranks ahead of the lender, and a lapsed policy leaves the property uninsured.

The math is simple. If yearly taxes are $6,000 and insurance is $2,400, the total is $8,400. Divided by 12, the borrower pays $700 a month into escrow.

Commercial and investor loans often hold other reserves the same way: replacement reserves for roofs and heating systems, tenant improvement reserves, or an interest reserve on a construction loan. The loan agreement sets these terms.

For home loans in the US, federal rules apply. Regulation X, under the Real Estate Settlement Procedures Act (RESPA), requires an annual escrow analysis for covered mortgages. It limits the cushion a servicer may hold to one-sixth of the year's expected payments, and it requires a refund of any surplus of $50 or more within 30 days. Business-purpose loans mostly follow the contract instead.

Why it matters for lenders

Escrow protects the asset that secures the loan, but it creates work and risk. The servicer is holding someone else's money, so balances must be tracked loan by loan and reconciled to the bank. Bills must be paid on time, since a missed tax date can bring penalties. When taxes or premiums rise, the monthly escrow amount has to rise too, or the account runs short.

Escrow also shapes how partial payments are split among escrow, interest and principal, so the payment waterfall must handle it.

How it works in practice

A private lender makes a $2 million loan on a small apartment building and requires escrow for taxes and insurance. At loan boarding, the servicer sets up the escrow balance, records the tax parcel number, due dates, insurance policy and renewal date, and collects an opening deposit at closing.

Each monthly payment includes the escrow amount. Two months before taxes are due, the servicer confirms the bill and checks that the balance covers it. Thirty days before the policy renews, it asks for proof of renewal. Once a year it compares money in with money out and resets the payment.

In spreadsheets, these dates live on someone's calendar. A tax bill gets paid late, or a premium increase is missed and the account goes negative. Keeping escrow balances, due dates and payments on the loan record shows shortages before they become problems.