Your Initial Escrow Payment for Property Taxes at Closing

When you get a mortgage, your lender establishes an escrow account to pay property-related expenses on your behalf. The purpose is to ensure property taxes and homeowners insurance are paid on time, protecting the property that serves as collateral for your loan. At your loan closing, you will make an initial escrow payment to fund the account. This upfront deposit provides a sufficient starting balance to cover upcoming bills before you have made enough monthly payments.

Components of the Initial Escrow Payment

The initial escrow payment is a collection of funds for recurring property expenses. The largest component is for property taxes, which are a mandatory expense for homeowners. By collecting a portion of these taxes at closing and with each monthly mortgage payment, the lender ensures funds are available to pay the bills directly and avoid tax liens on the property.

Another primary component is for homeowners insurance. Lenders require a hazard insurance policy to protect the home against damage from events like fire or storms. The initial payment includes funds to cover future premiums, guaranteeing the policy does not lapse and leave the lender’s financial interest uninsured.

In certain situations, the escrow account may also include funds for other required insurance. If your down payment is less than 20% of the home’s purchase price, you will likely need Private Mortgage Insurance (PMI). The escrow deposit will include funds for future PMI premiums. If the property is in a high-risk flood zone, federal law mandates flood insurance, and funds for these premiums will also be held in the escrow account.

Calculating the Initial Escrow Deposit

Calculating your initial escrow deposit starts with your total annual property-related expenses. Your lender will add your estimated annual property tax bill and your annual homeowners insurance premium, then divide the total by 12. This determines the base monthly amount added to your mortgage payment. For example, if annual property taxes are $4,800 and homeowners insurance is $1,200, your total annual escrow expense is $6,000, making the monthly escrow payment $500.

The Real Estate Settlement Procedures Act (RESPA) allows lenders to maintain a cushion in your escrow account to cover unexpected increases in property taxes or insurance. The maximum cushion is one-sixth of the total estimated annual disbursements, which equals two months of escrow payments. Using the previous example, a two-month cushion would be $1,000.

The calculation also involves timing, as the lender must collect enough at closing to pay the first large bills when they are due, plus the two-month cushion. Consider a home purchase closing on August 15th, with the first mortgage payment due October 1st. The annual property tax bill of $4,800 is due on December 1st. By then, you will have made only two monthly escrow payments (October and November), contributing $800 toward taxes ($400 x 2).

To ensure the $4,800 bill can be paid, the lender calculates the necessary upfront collection. In this scenario, the lender might collect four months of property tax payments ($1,600) at closing. Combined with the two-month cushion of $800, the initial tax portion of the escrow payment would be $2,400. This logic is also applied to the homeowners insurance schedule to determine the total initial escrow payment.

The Role of the Closing Disclosure

The breakdown of your initial escrow payment is on your Closing Disclosure, a document you receive at least three business days before closing. On page two, Section G, “Initial Escrow Payment at Closing,” itemizes the amounts for homeowners insurance and property taxes being collected. Each line shows the monthly payment amount and the number of months collected at closing.

It is important to distinguish Section G from Section F, “Prepaids.” Prepaids are upfront payments for expenses due at or immediately after closing, not funds for future bills. For instance, Section F shows the cost of your first full year’s homeowners insurance premium, paid directly to your provider at closing. It also includes per-diem mortgage interest that accrues between your closing date and the end of that month.

The difference is the purpose of the funds. The one-year insurance premium in Section F ensures your home is insured from day one. The funds for homeowners insurance in Section G are set aside to pay the premium for the following year. Similarly, prepaids in Section F might include property taxes due at closing, while the amount in Section G is collected to pay future tax bills.

Managing the Escrow Account After Closing

After closing, your escrow account is managed by your mortgage servicer, the company that collects your monthly payments. The servicer may or may not be your original lender and is responsible for making timely payments for your property taxes and insurance.

Your total monthly housing payment, known as PITI, combines Principal, Interest, Taxes, and Insurance. The principal and interest pay down your loan balance, while the tax and insurance portions are deposited into your escrow account. This structure means you make one payment to the servicer, who handles the disbursements.

Each year, your mortgage servicer conducts an annual escrow analysis. The servicer reviews past bills and projects future costs to determine if there is a surplus or shortage in your account. If there is a surplus of $50 or more, the servicer is required to send you a refund check.

If your property taxes or insurance premiums increased, you will likely have an escrow shortage, meaning the balance is below the required minimum. To correct this, the servicer will adjust your monthly mortgage payment for the next year to cover the higher costs and make up the shortage. You may also have the option to pay the shortage in a lump sum.