The monthly deposit is the easy part; the closing deposit depends on the bill calendar and on whether the reserves are pooled.
A commercial loan escrow collects one twelfth of the estimated annual taxes and insurance premiums with every monthly payment, and an initial deposit at closing large enough that the balance never falls short before a bill is due. With illustrative taxes of 480,000 and a premium of 180,000, the borrower pays 55,000 a month and, for a February closing, an initial deposit of 220,000, not the 55,000 of one month. Held in separate tax and insurance sub-accounts, the same bills need 280,000.
Worked in full in How to Read a Real Estate Loan Agreement by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
The usual wording obliges the borrower to pay, on each payment date, one twelfth of the taxes and insurance premiums the lender estimates will be payable over the next twelve months, and at closing an initial deposit sufficient, together with the monthly deposits, to pay each bill a stated number of days before it falls due. Thirty days is common. The lender pays the bills out of the reserve, and adjusts the deposits when the estimate changes.
The monthly figure is simple. The closing figure is not, because it depends on where the bills fall in the year relative to the closing date, and on whether one pooled reserve can use insurance money to pay taxes in the meantime.
| Input | Value |
|---|---|
| Annual real estate taxes | 480,000 |
| Paid in two instalments, end of April and end of October, each | 240,000 |
| Annual insurance premium, due 1 July | 180,000 |
| Funds required before each due date, days | 30 |
| Monthly tax deposit (480,000 / 12) | 40,000 |
| Monthly insurance deposit (180,000 / 12) | 15,000 |
| Monthly escrow deposit | 55,000 |
For each bill: shortfall = all bills due up to that date − monthly deposit × deposits made by the date funds are needed
Initial deposit = the largest shortfall over a full cycle of bills
Excel, one row per bill in date order: =SUM($C$2:C2)-D2*Monthly with D the number of deposits by the need-by date, then =MAX(E2:E7)
| Bill, funds needed by | Bills to date | Deposits made | Deposited | Shortfall |
|---|---|---|---|---|
| Taxes, 1 April | 240,000 | 2 | 110,000 | 130,000 |
| Insurance, 1 June | 420,000 | 4 | 220,000 | 200,000 |
| Taxes, 1 October | 660,000 | 8 | 440,000 | 220,000 |
| Taxes, 1 April, year 2 | 900,000 | 14 | 770,000 | 130,000 |
| Insurance, 1 June, year 2 | 1,080,000 | 16 | 880,000 | 200,000 |
| Taxes, 1 October, year 2 | 1,320,000 | 20 | 1,100,000 | 220,000 |
The pattern repeats each year, so the worst point is the October tax instalment and the initial deposit is 220,000. With that deposit, the reserve has exactly enough on 1 October and never goes negative.
Some agreements hold taxes and insurance in separate sub-accounts that cannot fund each other. Each then needs its own initial deposit.
| Sub-account, funds needed by | Bills to date | Deposits made | Deposited | Shortfall |
|---|---|---|---|---|
| Taxes, 1 April | 240,000 | 2 | 80,000 | 160,000 |
| Taxes, 1 October | 480,000 | 8 | 320,000 | 160,000 |
| Insurance, 1 June | 180,000 | 4 | 60,000 | 120,000 |
| Initial deposits, 160,000 + 120,000 | 280,000 |
Separation costs the borrower 60,000 more at closing, because the insurance money that sits idle in the pooled reserve between June and the following spring can no longer carry the tax instalments. If the lender also holds a cushion of two months of deposits, 110,000, the pooled deposit becomes 330,000. Escrow balances often earn nothing for the borrower: at 6 per cent the pooled 220,000 costs 13,200 a year, and 19,800 with the cushion.
| Closing month | Pooled | Separate sub-accounts |
|---|---|---|
| January | 165,000 | 225,000 |
| February | 220,000 | 280,000 |
| April | 90,000 | 150,000 |
| July | 75,000 | 135,000 |
| September | 185,000 | 245,000 |
Closing straight after a large bill is paid by the seller, as in April or July here, means more deposits accumulate before the next one. Closing in the weeks before an instalment means the deposit must carry most of it. The closing statement credits the buyer for taxes the seller has not yet paid, so part of a large escrow deposit is usually funded by the proration, a point covered in how rents and charges are prorated at closing.
Budgeting the initial deposit as one month's payment, or as the months elapsed since the last bill times the monthly deposit. On a February closing one month is 55,000, and the reserve would run 165,000 short of the October instalment; the lender then pays from its own funds, adds the advance to the debt and demands a catch-up. The second risk is the estimate itself: after a sale, many jurisdictions reassess taxes. If the next bills come in 20 per cent higher, the tax deposit rises from 40,000 to 48,000 a month and the total to 63,000, before any catch-up for the year already under way. A reserve sized on the seller's last bill is sized on the wrong number.
Escrows sit at the top of the loan's cash waterfall, ahead of debt service and well ahead of the borrower, so an underfunded reserve absorbs cash that the model assumed would reach the equity. See how the cash waterfall works in a CRE loan.
Reserves, cash traps and the waterfall are read clause by clause in the book, and the free workbook for this case carries the covenant arithmetic further.
Divide the lender's estimate of the next twelve months of taxes by twelve. On annual taxes of 480,000 that is 40,000 a month; insurance at 180,000 a year adds 15,000, for 55,000 with each debt service payment. The estimate is reset when a new bill arrives, so a 20 per cent tax increase lifts the tax deposit to 48,000 and the total to 63,000.
Because the deposits must reach each bill before it falls due, and a closing just before a large instalment leaves few monthly deposits to build the balance. On the same bills the pooled initial deposit is 75,000 for a July closing but 220,000 for a February one, where the first tax instalment is two deposits away.
Often not, unless the agreement or local law requires it, so the balance is a cost to the borrower. A 220,000 initial deposit carried at 6 per cent costs about 13,200 a year, and 19,800 if the lender also holds a two-month cushion of 110,000.
This article is one calculation from How to Read a Real Estate Loan Agreement. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
Get the book on Amazon →Free companion files
Also on Amazon UK · Amazon Germany · Amazon France · Amazon Canada
Reading guide: real estate investing, finance and fund management → · All 1523 articles →
If this book helped, or didn’t, a few lines on Amazon are worth more than they look: they are what the next reader goes on. Write a review. The workbook stays free either way.