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How does escrow work when buying a home?

Educational guide · Updated 2026

"Escrow" refers to two distinct things in a home purchase, and buyers often confuse them. The first is the escrow account used to hold funds during the transaction. The second is the ongoing mortgage escrow account used to pay taxes and insurance after closing. Both are important to understand.

Transaction escrow: during the purchase

When you make an offer and it's accepted, your earnest money deposit goes into an escrow account held by a neutral third party — typically a title company or escrow company (an attorney in some states). This account holds funds that don't belong to either party yet. If the deal closes, the funds are released to the seller. If it falls through due to a valid contingency, the funds are returned to the buyer. The escrow company also coordinates the collection and distribution of all closing funds — your down payment, closing costs, and the seller's proceeds.

Mortgage escrow: after closing

When you have a mortgage, your lender typically requires an escrow account for property taxes and homeowners insurance. Each month, a portion of your mortgage payment is deposited into this escrow account. When your property tax bill or insurance premium is due, the lender pays it from the account on your behalf. This protects the lender's interest in the property — ensuring these bills are always paid.

How lenders calculate your escrow payment

Your lender estimates the annual cost of your property taxes and insurance, divides by 12, and adds that amount to your monthly payment. They also typically collect a 2-month cushion at closing (the initial escrow deposit) to ensure the account has enough to cover bills when they come due. Each year, the lender performs an escrow analysis — if the account was over or underfunded, they'll adjust your payment accordingly or send a refund.

Can you opt out of escrow?

Some lenders allow borrowers with 20%+ equity and strong credit to waive escrow, handling tax and insurance payments themselves. This sometimes comes with a fee (escrow waiver fee, typically 0.25% of the loan amount). Most first-time buyers keep escrow — it removes the risk of a large tax or insurance bill arriving when you're not prepared for it.

What happens if my escrow account runs short?

The lender will send an escrow shortage notice and give you the option to pay the shortage in a lump sum or spread it across your payments over 12 months. Your monthly payment will also increase to prevent another shortage. This most commonly happens when property taxes are reassessed upward after purchase.

Why did I receive an escrow refund?

If your escrow account had more than the required cushion at the annual analysis, the lender is required to refund the excess (amounts over $50). This commonly happens when property taxes decrease or insurance rates drop.

Who holds the escrow during the transaction?

Typically a title company or escrow company. In some states (particularly on the East Coast), a real estate attorney handles closing and escrow. The entity is neutral — they don't represent buyer or seller.

Frequently asked questions

This article is educational and general in nature. Specifics vary by lender, loan program, and location. Confirm details with a licensed professional.