US mortgage escrow accounts: the cushion, shortages and waivers

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Kooky

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A home loan in the United States often comes with a second, smaller pot of money. Each month the borrower pays principal and interest, and on top of that an amount that the loan servicer sets aside to pay the property tax bill and the insurance premiums when they fall due. That pot is the escrow account, called an impound account in some parts of the country according to the Consumer Financial Protection Bureau (CFPB). Because property taxes and insurance premiums can change from year to year, the CFPB notes, the escrow payment and the total monthly payment change with them.

The account is tightly regulated. A federal rule, section 1024.17 of Regulation X, which implements the Real Estate Settlement Procedures Act (RESPA), says how much a servicer may collect, how the sums must be calculated, which statements the borrower receives and what happens when the balance turns out too low or too high. A second federal rule, section 1026.35 of Regulation Z, says when a lender must set the account up. This guide walks through both, with worked examples. One point of vocabulary first: the escrow of this guide is the account a servicer keeps for the life of a loan, which is a different thing from the escrow arrangement used to close a sale.

Regulation X, 12 CFR 1024.17, paragraphs (c), (g) and (f), as published in the Electronic Code of Federal Regulations and read on 10 October 2026.

What the account is and what it pays

Regulation X defines an escrow account as any account that a servicer establishes or controls on behalf of a borrower to pay taxes, insurance premiums, including flood insurance, or other charges on a federally related mortgage loan. An account that stays under the borrower's total control is outside the definition.

What goes through the account depends on the loan. Property taxes and the homeowner's insurance premium are the core. Fannie Mae's Selling Guide, which sets the terms for loans the company buys, lists taxes, ground rents, property insurance premiums, flood insurance premiums, borrower-purchased mortgage insurance premiums and special assessments. Regulation X adds that discretionary items, such as credit life or disability insurance, must be noted on the escrow statements when they are paid through the account.

The limits described below apply to federally related mortgage loans under RESPA. The CFPB states that they bind both at closing and in the recurring monthly payments.

How much a servicer may collect

Regulation X sets two ceilings, one for the day the account is created and one for every month after it.

During the life of the account, paragraph (c)(1)(ii) allows a monthly charge equal to one-twelfth of the total annual escrow payments the servicer reasonably anticipates, plus an amount needed to keep a cushion. The cushion is defined as funds the servicer may require to cover unanticipated disbursements, or disbursements made before the borrower's payments are available. Paragraph (c)(5) caps it at one-sixth of the estimated total annual disbursements. One-sixth of a year is two months, and the rule says so in its own method: the permitted cushion is two months of the borrower's escrow payments, or a lesser amount when state law or the mortgage document sets one.

At creation, paragraph (c)(1)(i) lets the servicer collect enough to cover the charges that run from the date each item was last paid until the borrower's initial payment date, worked out so that the lowest month-end balance projected for the coming year is zero. The same one-sixth cushion may be added on top.

Two further limits shape the calculation. Paragraph (c)(4) requires every servicer to use aggregate accounting, which means testing the account as a whole and not item by item. Paragraph (c)(6) prohibits the practice the rule calls pre-accrual.

Under paragraph (c)(7) the servicer uses the charge for the coming year when it is known. When it is not, the servicer may use the previous year's charge, increased if it wishes by no more than the latest yearly change in the national Consumer Price Index for all urban consumers, all items. For a newly built home that has not yet been assessed, the estimate is based on comparable residential property in the same market area.

The aggregate analysis, step by step

The calculation that produces the first deposit is called the aggregate analysis. Regulation X sets it out in paragraph (d)(2) in three moves.

The rule assumes each bill is paid on or before the earlier of the deadline for any discount and the deadline for avoiding a penalty. The balances that come out are maximums, known as target balances: the estimated month-end balance just sufficient to cover the remaining disbursements of the year, counting the payments still to come and the cushion. A servicer is free to hold less. The regulation refers to its Appendix E for official examples; the one below is this article's own, computed from the rule.

A worked example, with assumptions. A buyer closes in June and makes the first mortgage payment on 1 August. The property tax is estimated at US$4,800 a year, paid in two instalments of US$2,400 in November and May. The homeowner's insurance renews each June at US$1,800. Estimated yearly disbursements are therefore US$6,600, the monthly escrow payment is one-twelfth of that, US$550, and the largest cushion is one-sixth, US$1,100.

Step one, starting from zero: the balance dips to minus US$200 after the November tax instalment and reaches its low point of the year, minus US$550, when the insurance is paid in June. Step two adds US$550 to the opening balance to bring June to zero. Step three adds the US$1,100 cushion. The most the servicer may collect at closing is therefore US$1,650.

The account's single lowest month, June, sits exactly at the cushion. Paragraph (d)(2)(ii) makes that the test: the lowest monthly target balance may not exceed one-sixth of the estimated yearly disbursements.

One special case is written into the rule. When an item such as a flood insurance premium is billed every three years, paragraph (c)(9) has the servicer collect it in 36 equal monthly amounts. A three-year premium of US$1,800, to take an illustrative figure, becomes US$50 a month. The account then reaches its low point only once in the three-year cycle, and the yearly statement must explain why the low balance was not reached in the other two years.

The initial escrow statement

The borrower is told all of this in writing. Under paragraph (g)(1), when the escrow account is a condition of the loan, the servicer hands over an initial escrow account statement at settlement or within 45 calendar days of settlement. When an account is opened later and was not a condition of the loan, paragraph (g)(2) gives the servicer 45 calendar days from the day it is established.

The statement must show four things: the amount of the monthly mortgage payment and the part of it that goes to escrow; an itemised list of the estimated taxes, insurance premiums and other charges the servicer expects to pay during the first computation year, with the expected date of each payment; the amount chosen as the cushion; and a trial running balance, which is the month-by-month projection shown in the table above.

The computation year matters for everything that follows. Regulation X defines it as the 12-month period that begins with the borrower's initial payment date, and each 12-month period after that. In the worked example it runs from August to July.

The yearly analysis and the annual statement

At the end of each computation year the servicer must run a new escrow account analysis. The analysis is compulsory before the account is established and at the end of each computation year, and optional at any other time.

The result reaches the borrower in the annual escrow account statement, due within 30 days of the end of the computation year. Paragraph (i)(1) lists what it must contain, as a minimum:

• the current monthly mortgage payment and the part going to escrow;
• last year's monthly payment and its escrow part;
• the total paid into the account over the past year;
• the total paid out, with each charge identified separately;
• the balance at the end of the period;
• how any surplus is being handled;
• how any shortage or deficiency is to be paid;
• where it applies, why the estimated low monthly balance was not reached.

The CFPB describes the statements as giving the account's history and a projection for the year ahead.

There are exceptions. Under paragraph (i)(2) no annual statement is owed when, at the time of the analysis, the borrower is more than 30 days overdue, a foreclosure action has been brought or the borrower is in bankruptcy. If the loan is later brought current, the servicer supplies the account history since the last annual statement within 90 days.

A year can also be cut short. A servicer may issue a short year statement to change the computation year, and the borrower must receive it within 60 days of the end of the short year. When servicing is transferred, the outgoing servicer sends a short year statement within 60 days of the transfer; when the loan is paid off during the year, the statement follows within 60 days of the payoff funds being received.

Shortage, deficiency and surplus

Three words on the annual statement decide whether the payment goes up, goes down or comes with a cheque. Regulation X defines each one against the target balance at the time of the analysis. A shortage is the amount by which the current balance falls short of the target. A surplus is the amount by which it exceeds the target. A deficiency is something else: the amount of a negative balance, which arises when the servicer has paid a bill with its own money.

A surplus is tested by its amount and not against a month's payment. Under paragraph (f)(2), a surplus of US$50 or more is refunded to the borrower within 30 days of the analysis; a surplus under US$50 is either refunded or credited against the next year's payments.

The CFPB's servicing answers call the repayment options for a shortage exclusive: a servicer cannot invent another one. The borrower must be told of a shortage or deficiency at least once in each computation year.

A worked example, continuing the one above. During the first year the November tax instalment is paid as estimated at US$2,400, but the May instalment comes in at US$2,700 and the June insurance renewal at US$2,100. The account paid out US$7,200 against US$6,600 collected, so the July balance is US$1,050 and not the US$1,650 projected. The lowest month was June, at US$500; the balance never went negative, so there is no deficiency.

For the second year the servicer estimates tax of US$5,400 and insurance of US$2,100, a total of US$7,500. The monthly escrow payment becomes US$625 and the largest cushion US$1,250. Running the three steps again, the trial balance bottoms out at minus US$625 in June, so the target balance at the start of the year is US$625 plus US$1,250, or US$1,875. The account holds US$1,050. The shortage is US$825.

Because US$825 is more than one month's escrow payment of US$625, the servicer has two choices: leave the shortage in place, or collect it in equal monthly payments over at least 12 months. Over 12 months that is US$68.75 a month. The escrow part of the payment would then rise from US$550 to US$693.75, an increase of US$143.75 a month, of which US$75 reflects the higher bills and US$68.75 the catch-up. Had the account instead held US$1,950, the US$75 surplus would have had to be refunded within 30 days.

These protections depend on the borrower being current, which the rule defines as the servicer receiving payments within 30 days of their due date. When that is not the case, the servicer may keep a surplus, and recover a deficiency, as the loan documents provide.

Paying the bills on time

The other half of the bargain is the servicer's duty to pay. Under paragraph (k)(1) the servicer must make each disbursement on or before the deadline to avoid a penalty, a penalty being a late charge imposed by the payee. Paragraph (k)(2) goes further: if the account does not hold enough, the servicer must advance its own funds to pay on time. Both duties hold as long as the borrower's payment is not more than 30 days overdue. The servicer may then seek repayment of the advance under the deficiency rules, after running an escrow analysis, unless the advance was caused by the borrower's own payment default.

Property taxes have their own rule. Where the taxing jurisdiction offers no discount for paying the year in one sum and charges no extra fee for instalments, paragraph (k)(3) requires the servicer to pay by instalments. Where a discount or an instalment fee exists, the servicer may choose a lump sum, and the Bureau encourages it to follow the borrower's known preference without requiring it.

Homeowner's insurance is protected too. When a borrower with an insurance escrow is more than 30 days overdue, paragraph (k)(5) bars the servicer from buying force-placed insurance unless it is unable to pay the premium from escrow. Running out of escrow money does not count as being unable: the servicer is expected to advance the premium and recover it later. Inability exists only where the servicer reasonably believes the policy was cancelled or not renewed for a reason other than non-payment, or that the property is vacant.

When the law requires an escrow account

Lenders set their own policies, and the CFPB notes that many lenders require escrow. In two situations covered by the sources read for this guide, federal rules require it.

The first is the higher-priced mortgage loan. Regulation Z, at section 1026.35, defines it as a closed-end consumer loan secured by the borrower's principal dwelling whose annual percentage rate exceeds the average prime offer rate for a comparable loan by a set margin. The average prime offer rate is a benchmark the Bureau publishes in a table updated at least weekly, and the comparison is made as of the last date the loan's interest rate is set, or locked, before consummation.

For such a loan secured by a first lien on a principal dwelling, paragraph (b)(1) forbids the creditor from making it unless an escrow account is set up before consummation for property taxes and for the mortgage-related insurance the creditor requires. The official commentary adds that optional cover, such as earthquake or credit life insurance, need not be escrowed.

The rule has exemptions. No escrow is required for loans secured by shares in a cooperative, loans to finance the initial construction of a dwelling, temporary or bridge loans of 12 months or less, reverse mortgages and PACE transactions. Insurance premiums need not be escrowed for a home in a condominium, planned unit development or other common interest community where the association must keep a master policy covering all units. Two exemptions concern the lender and not the loan. A small creditor that lends in rural or underserved areas is exempt if, among other conditions, it and its affiliates made no more than 2,000 covered first-lien loans that were sold or transferred and hold assets under a threshold the official commentary sets at US$2,785,000,000 for 2026. An insured bank or credit union is exempt under similar conditions with assets up to US$12,485,000,000 for 2026 and no more than 1,000 covered first-lien loans in the preceding calendar year.

The second situation is the mortgage insured by the Federal Housing Administration (FHA). The Department of Housing and Urban Development's regulation at 24 CFR 203.23 requires the mortgage itself to provide for equal monthly payments from the borrower to cover ground rents, estimated taxes, special assessments, flood insurance premiums where flood insurance is required, and fire and other hazard insurance premiums. The lender holds the money to pay each item before it becomes delinquent. The same section protects the borrower on one point: the lender may not pass on a penalty or interest for a late tax payment if it held enough escrowed funds to pay before the charge was imposed.

When an escrow account can be waived or cancelled

Outside those cases, whether an account can be left out at closing depends on the lender and on whoever buys the loan. Fannie Mae's Selling Guide, in a section dated 1 April 2020, says first mortgages generally must provide for escrow deposits. It nonetheless allows a lender to waive the deposits for an individual first mortgage, unless the law requires them, on these conditions:

• the standard escrow clause stays in the loan documents;
• the lender has a written policy on waivers;
• the decision is not based on the loan-to-value ratio alone, and weighs whether the borrower can handle lump-sum payments of taxes and insurance.

Two things cannot be waived under that guide: the escrow of borrower-purchased mortgage insurance premiums, which is mandatory, and escrow on certain cash-out refinances where taxes are financed in the loan amount. For a unit covered by a blanket project policy, no insurance escrow is needed. The pages read for this guide do not set out any fee for a waiver, nor the rules of other loan buyers and insurers; those are open points.

An owner without escrow pays the bills directly. The CFPB sets out what can follow a missed payment: the taxing authority may impose fines and penalties, place a tax lien on the home or pursue foreclosure, and the lender may add the unpaid amounts to the loan balance, add an escrow account, or buy force-placed insurance and bill the owner for it.

For a higher-priced loan the account cannot be dropped at will. Under paragraph (b)(3) of section 1026.35 it may be cancelled only when the debt itself ends, which the commentary says includes repayment, refinancing, rescission and foreclosure, or on the borrower's request received no earlier than five years after consummation. Even then two conditions apply: the unpaid principal balance must be below 80 per cent of the property's original value, and the borrower must not be delinquent or in default. Original value is the lesser of the price in the sales contract and the appraised value at consummation, and a subordinate lien the creditor has reason to know of counts towards the balance. On a home bought for US$400,000, an illustrative figure, the balance would need to be under US$320,000.

What the rules leave to state law and the loan documents

Regulation X sets federal maximums, and a lower cushion governs when state law or the mortgage document provides one. When a borrower is behind on payments, the handling of a surplus or a deficiency follows the loan documents and not the federal options in the table above. State rules on escrow accounts were not among the sources read for this guide and are not described here.

The federal text also leaves the choice among the permitted options to the servicer: whether a shortage is spread over 12 months or left in place, and whether a small surplus is refunded or credited. A borrower who believes an account has been handled wrongly can submit a complaint to the CFPB, which says companies generally respond within 15 days.

Kooky, from Shaka

Kooky edits Agents Estate and builds Shaka, the payment router he made for real estate professionals. One payment comes in, and every agent, agency and party in the deal receives their signed share on closing date.

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