Learn why your payment may include an escrow amount.

When you purchase your home, your lender will give you the option to establish an escrow account as a way to pay the annual property taxes and insurance premiums owed for the property. These payments are included in your monthly mortgage payment along with the principal and interest. However, unlike the principal and interest, which are paid to your lender, the portions of your monthly payment allocated to property tax and insurance are held in your escrow account. The account works as a holding tank for the funds. When it comes time to pay property taxes and insurance premiums each year, those payments will be withdrawn from the escrow account.

Your lender will estimate your property taxes owed each year based on the previous year. Typically, the property taxes you owe will remain relatively stable year to year. However, when there is an increase or decrease, your monthly mortgage payment will be adjusted to reflect the change. This is referred to as an escrow shortage or an escrow overage.

It can come as a shock to get a notification of an increase in your mortgage payment as a result of an escrow shortage. When there is an increase in property value there will usually be an increase in taxes to reflect that change. This triggers an escrow shortage and your monthly mortgage payments will be higher as a result. While it can be frustrating to have your mortgage payments increase, there is a silver lining — rising property taxes reflect an increase in the value of your home and that means equity for you.

In contrast, if the lender’s estimate of your property taxes is too high, the result is an overage. When an overage occurs, the lender will issue a check for the difference and reduce your monthly payments.

Please note that in some cases where the loan-to-value ratio exceeds certain limits an escrow account may be required.