What Is an Escrow Shortage?

An escrow shortage occurs when there is insufficient money in your escrow account to pay bills, which is funded by your monthly mortgage payment and determined by a yearly escrow analysis.

When you purchase a home, it comes with many additional expenses, including homeowners insurance and taxes. Like most homeowners with a mortgage, you don't pay these directly. Instead, the funds for these annual expenses are included in your monthly mortgage payment and will go into an escrow account. An escrow account holds funds to pay property taxes and homeowners insurance. Read on to understand what happens if you end up with an escrow shortage and the steps needed to resolve it. 

Understanding Escrow Accounts

An escrow account is an account that holds money or assets until the money is ready to be used and certain criteria have been met. For example, when you make an earnest money deposit to buy a home, the money is held in an escrow account until all contingencies are met. You don't control this account; the escrow holding account makes the necessary payments. 

A mortgage-related escrow account holds the funds you need to pay your property taxes and homeowners insurance. Your monthly mortgage payment comprises four parts: principal, interest, taxes, and insurance, often abbreviated as PITI.

The principal and interest you pay the mortgage lender relate directly to your mortgage repayment. The taxes and homeowners insurance payments don't go directly to the lender. The lender collects these as part of your mortgage payment, and then they are kept in a third-party escrow account until the bills are due. The escrow service will pay the bills on your behalf when they are due. 

What Is an Escrow Shortage?

A mortgage-related escrow account is funded by your monthly mortgage payments. An escrow shortage occurs when your escrow account balance is below the minimum balance required or is projected to be below the minimum balance within the next 12 months. This usually happens when property taxes or homeowners insurance increases or there are unexpected taxes to cover. 

The required balance with most lenders is two months of escrow payments. This minimum is designed to protect you so you have enough funds in the account to cover unexpected additional tax or insurance increases.  

Factors that can contribute to an escrow shortage include changes in the property's valuation, leading to increases in property taxes or increases in insurance premiums.

Reasons you might have an escrow shortage include:

• Your property taxes increased
• Your taxes were reassessed
• Your insurance provider changed
• Your insurance premiums increased
• Your property tax or insurance premium due date changed
• You made fewer escrow payments than expected
• Higher payouts in the previous year mean your starting escrow balance for the 12 months was lower than expected 

Example of an Escrow Shortage

Here's an example of how an escrow shortage can occur. Suppose your annual property tax payment is $150 per month, while homeowners insurance is $100 monthly. You pay this $250 as part of your total monthly mortgage payment. For example, if you have a $1,500 monthly mortgage payment, $1,250 will go toward principal and interest, and the remaining $250 will be held in an escrow account. 

Suppose that at the time of your escrow analysis, your taxes have been assessed and increased to $200 per month. The actual annual amount comes to $2,400 for taxes and $1,500 for homeowners insurance. That's a $900 difference.

TAXES: 

$2,400 – Actual

-$1,800 – escrow analysis prediction

=$600 Difference

INSURANCE: 

$1,500 – actual

-$1,200 – escrow analysis prediction

=$300 difference

Total escrow shortage: -$1,000 for the taxes plus insurance bill

You’re responsible for paying the $900 to make up the difference. After the new escrow analysis, your monthly mortgage payment would increase to cover this difference each month. That means your monthly mortgage payment would increase by $50 for taxes and $25 for insurance. 

What Are the Consequences of an Escrow Shortage?

An escrow shortage occurs when you don't have enough money in your escrow account to cover the actual bills. For that reason, you'll need to make up the difference.

The potential consequences of an escrow shortage vary by lender. Sometimes, the shortfall will be divided over the coming 12 months. For the $900 shortfall in the example above, you'll need to pay an extra $75 per month to make up the difference, plus the $75 a month for the higher taxes and insurance. For that year, you'll need to pay an extra $150 per month. 

In other cases, you'll be required to pay the difference immediately. You'll also see an increase in your monthly mortgage payments to reflect this increase in taxes and insurance.

Can Escrow Shortage Payments Affect Mortgage Rates?

Mortgage rates are not directly correlated with your escrow payment. In the case of a fixed-rate mortgage, the interest rate remains steady, however, this does not guarantee that the payment amount will remain unchanged. In a fixed-rate mortgage, the payments towards the principal and interest remain constant. It is the taxes and insurance that have the potential to fluctuate and impact the monthly payment.

What Happens if You Can’t Afford to Pay the Escrow Shortage?

If you cannot afford to pay the escrow shortage, you should contact your lender to discuss potential solutions, such as setting up a payment plan or refinancing options. Many lenders will allow you to spread the extra costs over the next 12 months and increase your mortgage payments.

How to Prevent Future Escrow Shortages

To prevent future escrow shortages, regularly review and update your escrow account to ensure accurate estimates for taxes and insurance. You can also monitor any property tax or insurance premium changes to avoid increases that could lead to an escrow shortage. 

How to Stay Ahead of Escrow Shortages

If you have a mortgage, you'll usually have an escrow account where a portion of your mortgage payment for property taxes and insurance is held. If these costs go up, you could face an escrow shortage that prevents payment of these bills. To fix an escrow shortage, you'll usually have the option to pay the entire shortage amount at once or spread it out in payments over a year. Sometimes, you can use a mix of both.

You may be able to avoid escrow shortages by monitoring property tax assessments and insurance premiums. In the case of a reduction in assessed value or property taxes, you might have an escrow surplus. Ideally, build up extra savings so you are prepared to cover escrow shortages. Preparing to buy a home? Learn more about how to qualify for a mortgage here. 

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