What is a Loan Escrow Account and How Does it Work?

When you purchase a home, your mortgage lender will open an escrow account to pay your taxes and insurance. This account is funded by a portion of your monthly mortgage payment. The money in the account is used to pay for property-related expenses such as taxes, insurance, mortgage insurance, and flood insurance. Depending on the lender, you may be able to get a discount on your interest rate or closing costs by having an escrow account.

Banks use the loan-to-value ratio (LTV) to determine if their home loan will require an escrow account. If the mortgage amount is 80% or less of the value of the home, you may be able to avoid the security deposit. An escrow account is a common financial tool used by lenders and servicers to ensure that your obligations as a homeowner are met without much effort on your part. When you make your full monthly payment, part goes to your mortgage to pay principal and interest, and another part goes to your escrow account.

For VA loans, you'll need a 10% down payment and a strong credit profile to stop having an escrow account. Your lender or servicing entity must send you an annual escrow statement showing the amounts you have paid (and the reductions) along with any excess or shortage. To ensure that there is sufficient cash in custody, most lenders require that a minimum of 2 months of additional payments be held in your account. Having your lender or mortgage servicer keep your property tax and home insurance payments in custody ensures that those bills are paid on time and automatically.

The lender or mortgage servicer keeps these funds in an escrow account and makes payments as they come due on behalf of the homeowner.