A mortgage payment usually contains more than principal and interest. The lender collects a share of the annual property tax and insurance bills each month and pays them when due.
The account exists to protect the collateral
Unpaid property taxes create a lien that ranks ahead of the mortgage, so a tax default can put the lender behind a government claim on the same property.
Lapsed hazard insurance leaves the collateral unprotected against the events most likely to destroy its value.
Escrow removes both risks by taking the payment out of the borrower's hands entirely, which is why it is required on most loans rather than offered.
The monthly collection is an estimate that gets revised
The servicer estimates the coming year's tax and insurance bills, divides by twelve and adds that to the payment.
Because the underlying bills change annually, the estimate is reviewed each year and the monthly collection is adjusted up or down.
A reassessment after a purchase frequently raises taxes sharply, which is the most common reason a payment jumps in the second year of ownership.
A cushion is held against timing risk
Servicers are permitted to hold a limited reserve above the expected outgoings, since bills can arrive before enough has been collected.
The size of that cushion is capped by regulation, and the annual analysis compares the actual balance against what the rules allow.
Surpluses above the permitted level are refunded to the borrower, while shortages are recovered either as a lump sum or spread across the following year.
Shortages compound the payment increase
When a bill exceeds the estimate, two things happen at once: the shortfall must be made up and the monthly collection must rise to cover the new higher bill.
Borrowers therefore see an increase larger than the underlying bill increase, because they are catching up and prefunding simultaneously.
The catch-up portion falls away the following year, so the payment often steps up and then partially retreats.
Waiving escrow shifts the obligation, not the cost
Some lenders allow escrow to be waived where the equity position is strong, sometimes in exchange for a small rate adjustment.
The borrower then receives the bills directly and must reserve for them, which suits a disciplined household and punishes an unprepared one.
The total paid is the same either way, so the decision is about who holds the money in the meantime and who bears the consequence of missing a deadline.