What In The World Is An Escrow Shortage?

If you’re like a majority of homeowners today, you have a mortgage with an escrow account. And, like most of those homeowners, you may understand the basics of escrow. But when it comes to shortages and overages, it can be difficult to keep it all straight.

An escrow account is an account that holds the funds you need to pay your property taxes and homeowners insurance. It’s not an account that you manage directly. It’s simply a holding account that contains the funds you pay every month to ensure your taxes and insurance bills are paid.

By consolidating these payments into your monthly mortgage payment, you only have to worry about one bill rather than several bills all due at different times. Your mortgage lender helps by making sure you have enough money in your account to cover your bills; then when the bills are due, they pay them on your behalf. It’s a service that is designed to make your life easier.

An escrow shortage is when you don’t have enough money in your escrow account to cover the actual amount needed to pay your bills. Money for the escrow account comes directly from your monthly mortgage payment. How much of the money you pay that goes to your escrow account is determined by your yearly escrow analysis.

When you’re looking at your payment amount, it’s helpful to view the payment as two categories: one for principal and interest (the amount that goes toward paying off your home loan) and the other for property tax, homeowners insurance and mortgage insurance.

What Causes An Escrow Shortage?

Escrow shortages can occur when trying to estimate the taxes due in the coming year or predict changes in insurance premiums. Your mortgage lender is responsible for estimating these amounts, as they manage your escrow account. Sometimes these amounts are overestimated, resulting in an escrow refund. But when they’re underestimated, you have an escrow shortage. In situations like this, you’ll most likely have to make an escrow shortage payment.

For example, if you buy a home that was built for you, your initial tax assessment will more than likely only consider the land value of the home. But once the property is assessed again, it will include the land value plus the value of your home. As a result, your property taxes will increase and so will your escrow payment. This means, ultimately, your monthly mortgage payment will increase.

Escrow Shortage Example

If your annual tax payment is projected to be $2,400, $200 goes to your escrow account every month ($2,400 divided by 12 months in a year). If your projected insurance amount is $1,200, $100 goes to escrow every month.

So, if you have a $1,200 monthly mortgage payment, $900 goes toward your principal and interest, while the remaining $300 goes toward your escrow account every month.

However, at the time of your escrow analysis, let’s say that your taxes have been assessed and they have increased from the amount your mortgage lender thought they would be during last year’s analysis. The actual amount comes in at $3,000 for taxes and $1,600 for homeowners insurance – that’s a difference of $1,000 from the analysis estimate.

TAXES:

• Escrow Analysis Prediction: $2,400
• Actual Tax Amount: $3,000
• Difference: -$600

INSURANCE:

• Escrow Analysis Prediction: $1,200
• Actual Insurance Amount: $1,600
• Difference: -$400

Total Shortage For Tax/Insurance Bill: $1,000

At this point, you’re responsible for the $1,000 required to make up the total amount due for your taxes and insurance. Additionally, you’ll notice an increase in your monthly mortgage payment. The reason for this increase is to cover the newly assessed taxes and homeowners insurance.

An escrow shortage occurs when there is a positive balance in the account, but there isn’t enough to pay the estimated tax and insurance for the future. An escrow deficiency is when there’s a negative escrow balance in the account. This happens when the mortgage lender has to advance funds to cover disbursements on your behalf. So not only will you be short for your upcoming tax and insurance payment, but you will also owe money to bring your account current.

Your mortgage lender will look for changes in tax and insurance in the form of an escrow analysis once a year. However, if they see an issue that requires further examination, they can run an off-schedule analysis to determine its impact on your payment.

Below are strategies you can use to be better prepared for changes in your escrow account that result in an escrow shortage payment:

1. Pay attention to information from your city or homeowners insurance company. They will often send you information in the mail about trends and increases, which can help you plan ahead.
2. Keep an eye on insurance trends. Shop around to make sure you’re getting the best rate you can.
3. Set aside money to use as an escrow backup plan. This way if your escrow account does wind up short, you’ll have the extra funds to pay it immediately.

Mortgage rates have nothing to do with your escrow payment. For example, if you have a fixed-rate mortgage, you can expect the rate to remain the same, but not necessarily the payment. With a fixed-rate mortgage, the amount you pay toward your principal and interest doesn’t change. The amount that can fluctuate and affect your monthly payment are the taxes and insurance.

When your escrow account is short by a certain amount, the resulting escrow shortage payment is twice that amount. This is because one-half of the payment goes toward the negative escrow balance, and the other half covers a future payment to prevent a shortage from taking place the following year.

As an example, let’s say you receive an escrow analysis statement saying your escrow account is short because your homeowners insurance went up by $800. Yet, the escrow shortage payment amount is $1,600. Half of the escrow shortage payment covers this year’s insurance increase of $800. The other $800 makes up the difference for a future insurance payment. In effect, you are caught up on payments for this year and are protected in the event of a similar shortage next year.

Escrow accounts can ease the burden of annual tax and insurance payments that come with a mortgage. However, borrowers should be aware that changes to taxes or insurance rates can result in an escrow shortage and an increased monthly payment, even for a fixed-rate mortgage.

For homeowners, it's not always easy to be prepared in the event of an unforeseen payment increase. That's why it's wise to monitor your escrow account and have some money saved in the case of an escrow shortage.

If you're interested in reducing your monthly mortgage expenses, refinancing may be the solution you're looking for. Learn more about your options and start the initial approval process online with Rocket Mortgage^®.