Key takeaways

  • PITI stands for principal, interest, taxes and insurance, the four parts of a typical monthly mortgage payment.
  • An escrow account is managed by your loan servicer to pay property taxes and insurance bills on your behalf.
  • Your servicer reviews the account at least once a year. Tax or premium changes can raise or lower your payment, even on a fixed-rate loan.
  • Federal rules limit how large a cushion a servicer can hold and require refunds of larger surpluses when your payments are current.

Many new homeowners are surprised that their mortgage payment is larger than the principal-and-interest figure they focused on, and surprised again when that payment changes a year later on a loan with a fixed rate. Both surprises usually trace back to the same two things: PITI and the escrow account.

What PITI means

  • Principal: the part of the payment that reduces what you owe.
  • Interest: the lender’s charge for the loan.
  • Taxes: property taxes, set by your local taxing authorities.
  • Insurance: homeowners insurance, plus mortgage insurance or flood insurance when required.

Homeowners association dues are usually paid directly to the association rather than through your mortgage. Lenders often count them anyway when they judge whether a payment is affordable, which is why you will sometimes see the term PITIA.

Illustrative example: building a monthly payment
Principal and interest ($300,000 at a hypothetical 6%, 30 years)
$1,798.65
Property taxes ($3,600 a year ÷ 12)
$300.00
Homeowners insurance ($1,800 a year ÷ 12)
$150.00
Monthly PITI payment
$2,248.65

Hypothetical figures for illustration. Actual taxes and premiums vary widely by location and property.

Two different meanings of escrow

You may hear the word escrow twice in the home-buying process. During the purchase, escrow refers to a neutral third party holding money and documents, such as your earnest money deposit, until the sale closes. After closing, an escrow account, sometimes called an impound account, is the account your servicer uses to pay recurring property bills. This guide is about the second meaning.

How an escrow account works

At closing

You typically make an initial deposit into the account so it has enough to pay the first bills as they come due. These amounts appear on your Loan Estimate and Closing Disclosure as prepaids and initial escrow payment at closing.

Every month

Part of each mortgage payment, roughly one-twelfth of the estimated yearly tax and insurance bills, goes into the account.

When bills are due

The servicer pays your tax authority and insurance company directly. You should not also pay those bills yourself unless your servicer asks you to.

The cushion

Under the federal Real Estate Settlement Procedures Act, a servicer may keep a cushion in the account to cover unexpected increases. That cushion cannot exceed one-sixth of the estimated annual escrow payments, or about two months’ worth.

The annual escrow analysis

At least once a year, your servicer compares what it collected with what it paid, estimates the coming year’s bills and sends you an annual escrow statement. One of three things happens:

  • The account is on track. Your escrow payment may still be adjusted to match next year’s estimates.
  • There is a shortage. Bills rose faster than expected. Depending on its size, the servicer may spread the shortfall across the next year’s payments, and it may accept a one-time payment if you would rather cover it all at once.
  • There is a surplus. If it is $50 or more and your payments are current, the servicer generally must refund it within 30 days. Smaller amounts may be refunded or credited.

This is why a fixed-rate payment can change. The rate did not move; the property tax assessment, the local tax rate or the insurance premium did.

Check it when it arrives

Your annual escrow statement deserves ten minutes of attention. Confirm that the tax and insurance amounts match your actual bills. Mistakes do happen, and they are much easier to fix when caught early.

Is an escrow account required?

Often, yes. FHA loans generally require escrow, and conventional lenders commonly require it when the down payment is under 20 percent. Federal rules also require escrow for at least the first five years on certain higher-priced mortgages. With some conventional loans and enough equity, a lender may let you pay taxes and insurance yourself, sometimes in exchange for a fee or a slightly higher rate.

Paying on your own means budgeting for large bills that arrive once or twice a year. If insurance lapses, the servicer can buy a policy on your behalf and charge you for it. That coverage is usually more expensive and is designed mainly to protect the lender.

Habits that keep escrow predictable

  • Open every notice from your servicer and your local tax office.
  • If you believe your property assessment is wrong, look into your local appeal process. Deadlines are strict and set locally.
  • If you change insurance companies, tell your servicer and send proof of the new policy so the right company is paid.
  • Keep your year-end mortgage statement, which typically shows interest paid and may show property taxes paid from escrow.

Helpful official resources

About this guide. OwnMG publishes general educational information. It is not financial, legal or insurance advice, and OwnMG is not a lender, insurer, broker or government agency. Rules, limits and fees change, so confirm current details with your lender or the agency involved. Spotted something out of date? Tell us at info@ownmg.com.