How Do I Figure Escrows?

September 6, 1999, Revised March 21, 2011

"My loan officer tells me I need to deposit $1157 into an escrow account at closing to take care of future taxes and hazard insurance payments, but when I asked him where that number came from he said 'it is set by HUD' and was unable to explain it further. Can you shed any more light on this?"

Rationale For Escrows

Lenders generally require that they assume responsibility for the payments of taxes and insurance so that they can be sure that the payments are made. Borrowers can often get the requirement waived, but only by paying a fee at origination. See How Can I Avoid Escrows on My Mortgage?

The requirement is that an escrow account be established with the borrower's funds, from which the lender makes the payments as they come due. The escrow account is established with a deposit that the borrower provides at closing. To assure themselves that there will always be enough money in the account, lenders ask for more than they actually need as a "cushion".

The HUD Rule Limiting Escrows

Since lenders usually get to keep the interest on escrow accounts, in years past, many of them maintained unreasonably large cushions. To deal with that, the Department of Housing and Urban Development (HUD) issued a ruling that placed a ceiling on the size of escrow accounts, which in turn limited the amount the lender could ask the borrower to deposit at closing.

The rule is that the deposit cannot exceed the amount needed to prevent the balance from falling below an amount equal to 2-months worth of tax and insurance payments at its lowest point during the year. While HUD does not do a lot of enforcing, my impression is that all but a handful of lenders follow the HUD rules.

Calculating the Escrow Deposit Required at Closing

  Add the annual taxes and insurance premiums and divide by 12. This is the amount that will be included in your mortgage payment and added to the escrow account every month.

You can calculate the maximum initial deposit using a worksheet with 3 columns and 12 rows.

    *Column 1 is "Month" beginning the month in which your first monthly payment is due.
    *Column 2 is "Tax and  Insurance Payments" shown in the month in which they are due.
    *Column 3 is "Escrow Account" showing the amount available assuming no initial deposit at closing.

When you have calculated the amount in the escrow account every month, find the month with the smallest deposit, which is probably negative. The required deposit is equal  to the shortfall plus 2-months of payments, which is the allowable cushion under HUD's rules.

Here is an example:

* The first payment is due in November.
* County tax of $1000 is due in August.
* School tax of $2600 is due in August.
* Insurance payment of $960 is due in March

The tax escrow deficiency of $600 in August, plus a 2-month cushion of $600, results in a required deposit of $1200 at closing. The insurance escrow deficiency of $560 in March, plus a 2-month cushion of $160, results in a required deposit of $720 at closing. The total amount due at closing is $1200 + 720 = $1920.


Tax  Payments

Tax Escrow Insurance Payment

Insurance Escrow



$300   $80



600   160



900   240



1200   320






  1800   -480



2100   -400



2400   -320



2700   -240



-600   -160



-300   -80





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