What Is an Escrow Account and Why Do Lenders Require It?
An escrow account is a separate account managed by your mortgage servicer that collects and pays your property taxes and homeowner's insurance on your behalf. Each month, a portion of your total mortgage payment goes into escrow. When tax bills and insurance premiums come due — typically annually or semi-annually — your servicer pays them from the accumulated escrow balance. Lenders require escrow accounts on most conventional mortgages to protect their collateral: if taxes go unpaid, the government can place a lien on the property, and if insurance lapses, the lender's security interest is exposed.
RESPA (Real Estate Settlement Procedures Act) governs escrow accounts and limits how much your servicer can require you to keep in reserve — typically no more than a two-month cushion above the amount needed to pay upcoming bills. At closing, you'll prepay several months of escrow to establish the account. Your monthly escrow payment is recalculated annually during the escrow analysis, and your total payment adjusts accordingly if tax assessments or insurance premiums change.
Understanding PITI: The True Cost of Homeownership
PITI stands for Principal, Interest, Taxes, and Insurance — the four components of a complete mortgage payment. Many first-time homebuyers focus entirely on the P&I payment quoted by lenders and are surprised by the full PITI when they close. For a $350,000 home in a state with a 1.2% property tax rate and standard homeowner's insurance, the escrow alone adds approximately $467 per month on top of the mortgage principal and interest payment.
Lenders use PITI when calculating your housing-to-income ratio for qualification. The standard guideline is that PITI should not exceed 28% of gross monthly income. At the median US home price, reaching this threshold often requires incomes well above the median in high-tax or high-insurance states. Understanding the full PITI before shopping for homes prevents the common mistake of qualifying for a mortgage and then being house-poor once taxes and insurance are factored in.
PMI: What It Is and When It Disappears
Private mortgage insurance (PMI) is required on conventional loans when the down payment is less than 20% of the purchase price. It protects the lender — not the borrower — against default. PMI typically costs 0.5%-1.5% of the loan amount annually, adding $125–$375 per month on a $300,000 loan. This cost disappears once you reach 20% equity in the home. Under the Homeowners Protection Act, you can request PMI cancellation when your loan-to-value ratio reaches 80% based on original value. Servicers must automatically cancel PMI when it reaches 78%.
For FHA loans, mortgage insurance premium (MIP) works differently — it includes an upfront premium at closing plus an annual premium. Unlike conventional PMI, FHA MIP typically stays for the life of the loan if the down payment was less than 10%. Homeowners with FHA loans who have built equity often refinance to a conventional loan specifically to eliminate the permanent MIP.
Property Tax Rates Vary Enormously by Location
Effective property tax rates range from under 0.3% in Hawaii and Alabama to over 2.2% in New Jersey and Illinois. The same $400,000 home costs just $1,200/year in taxes in Alabama but over $8,800/year in New Jersey. Property tax assessments also vary — some jurisdictions assess at full market value, others at a fraction. Your actual tax bill is determined by the assessed value times the mill rate (tax per $1,000 of value). Checking your county assessor's website or using your most recent tax bill provides the most accurate input for this calculator rather than relying on state averages.