What Is a Shortage in Escrow and What Should I Do?
Understand what a mortgage escrow shortage is, its causes, and clear steps to effectively resolve it.
When you obtain a mortgage, lenders often establish an escrow account as part of your loan agreement. This account holds funds from your monthly mortgage payment, earmarked to cover property-related expenses like property taxes and homeowner’s insurance premiums. Its primary purpose is to ensure these significant recurring costs are paid on time, protecting both the homeowner’s investment and the lender’s security interest. An escrow shortage occurs when the funds in this account are not enough to meet these financial obligations.
Understanding an Escrow Shortage
An escrow shortage arises when the money held in your escrow account is insufficient to cover the property taxes and homeowner’s insurance premiums that your mortgage lender pays on your behalf. Even if there is a positive balance, it is still considered a shortage if the amount falls below the required minimum needed for upcoming disbursements. This situation means that the estimated amounts collected over the past year were less than the actual costs of these property-related expenses. Your mortgage servicer typically identifies an escrow shortage through an annual escrow analysis. This yearly review assesses the activity within your escrow account over the previous 12 months and projects the anticipated expenses for the next year, determining if your monthly contributions are adequate to cover the required payments.
Common Causes of Shortages
Escrow shortages frequently occur due to increases in the underlying costs that the account is designed to cover. One common reason is a rise in property taxes. This can happen because of a reassessment of your property’s value, which might increase due to market appreciation in your area or significant home improvements you’ve made. Local taxing authorities might also increase tax rates to fund public services, leading to higher tax bills.
Increases in homeowner’s insurance premiums are another frequent cause of shortages. Factors such as inflation, rising costs of building materials and labor for repairs, or an increase in the frequency and severity of natural disasters can drive up insurance rates across the industry. Additionally, if you or your neighbors have filed claims, or if there are changes in your neighborhood’s risk profile, your premiums may also increase. Sometimes, the initial estimation of escrow needs at loan closing might have been too low, resulting in an underfunded account from the start.
Resolving an Escrow Shortage
When an escrow shortage is identified, your mortgage lender will typically provide you with options to address the deficit. A common approach is to pay the entire shortage amount in a single lump sum payment. This one-time payment brings your escrow account back to the required balance, preventing it from being spread across your future mortgage payments. Paying the shortage in full can help keep your monthly mortgage payment closer to its previous amount.
Alternatively, most lenders allow you to spread the shortage amount over a period, typically 12 months. In this scenario, the shortage is divided and added to your regular monthly mortgage payments until the deficit is covered. This option can make the shortage more manageable by distributing the financial impact over a longer timeframe. It is important to note that even if you pay the current shortage, your monthly escrow payment for the upcoming year will likely still increase to account for the higher projected property tax and insurance costs that caused the shortage in the first place. Reviewing the annual escrow analysis statement from your lender thoroughly and contacting them with any questions is a prudent step to ensure you understand the changes and options available.