What is the purpose of escrow for taxes and homeowners insurance, and what item is included in monthly payments?

• A. To accumulate funds for tax and insurance payments; monthly PITI includes the escrow portion.
• B. To fund principal reduction.
• C. To cover HOA dues only.
• D. To pay mortgage insurance premium only.

Answer: (A)

Escrow is a reserve set aside to ensure property taxes and homeowners insurance are paid on time. Lenders require this so taxes and insurance don’t lapse and to protect their security. Each month, part of the mortgage payment goes into the escrow account; when bills are due, the lender uses those funds to pay them. The total monthly payment includes principal, interest, taxes, and insurance, often referred to as PITI, with the escrow portion covering the taxes and insurance.

For example, if annual taxes are $3,600 and annual homeowners insurance is $1,200, the escrow portion would be $400 per month, added to the monthly payment along with principal and interest. This arrangement keeps budgeting predictable and prevents large, irregular expenses from catching the borrower by surprise.