What Does It Mean When You Have an Escrow Shortage?

Mortgage escrow accounts are a common part of homeownership, designed to simplify the payment of property-related expenses. These accounts manage recurring costs separate from the mortgage principal and interest. Understanding their function helps homeowners avoid unexpected financial adjustments. This article explains what an escrow shortage is and its implications for homeowners.

Understanding Your Escrow Account

An escrow account, also known as an impound account, is a dedicated financial account established by a mortgage lender or servicer. Its purpose is to collect and hold homeowner funds for property-related expenses like property taxes and homeowner’s insurance premiums. Including these costs in the monthly mortgage payment ensures timely payment, reducing the risk of penalties or coverage lapses.

The mortgage servicer manages this account. Each month, a portion of the mortgage payment is deposited into the escrow account. When tax bills or insurance premiums are due, the servicer uses these funds to make payments. This system helps homeowners budget for large, infrequent expenses by spreading them into smaller, predictable monthly contributions.

Identifying an Escrow Shortage

An “escrow shortage” occurs when the money held in your escrow account is not enough to cover anticipated property taxes and insurance premiums. This means the balance has fallen below the required level for upcoming disbursements. Even if there is some money in the account, it is still considered a shortage if it cannot fully meet the projected expenses.

Mortgage servicers typically discover an escrow shortage during an annual escrow analysis. This yearly review compares the funds collected in the past 12 months with actual expenses paid, and projects costs for the upcoming year. Homeowners are then notified of any shortage through an escrow analysis statement. This statement details the account activity and indicates whether the monthly escrow payment needs to be adjusted.

Reasons for Escrow Shortages

Several factors can lead to an escrow shortage, often due to increased costs the account covers. A common reason is higher property taxes. Local tax authorities may reassess property values or introduce new levies, leading to higher annual tax bills. If previous escrow contributions were based on lower tax amounts, a shortage can occur.

Increased homeowner’s insurance premiums are another frequent cause. Premiums can rise due to inflation, higher repair costs, or changes in claim history. Policy changes or switching insurance carriers mid-year also impact the required escrow amount. Additionally, increases in other escrowed items, such as private mortgage insurance (PMI) or flood insurance, can contribute. Sometimes, initial lender estimates at loan closing might have been too low, underfunding the account from the start.

Resolving an Escrow Shortage

When an escrow shortage is identified, homeowners typically have options to address the shortfall. The mortgage servicer will present these choices after the annual escrow analysis. One common method is to pay the entire shortage amount in a single lump sum payment. This one-time payment brings the escrow account balance up to the required level immediately. Even if a lump sum payment is made, the monthly escrow payment may still increase for the upcoming year to account for the higher ongoing costs of taxes and insurance.

Alternatively, homeowners can choose to spread the shortage amount over a period, typically the next 12 months. This option results in an increase in the homeowner’s regular monthly mortgage payment, as the shortage is divided and added to each installment. This approach makes the payment more manageable by avoiding a large upfront expense. Mortgage servicers are generally required to offer these repayment options, allowing homeowners flexibility in addressing the shortage.