What Is an Escrow Shortage Amount and What to Do?
Gain clarity on mortgage escrow shortages. Understand what this financial adjustment means for homeowners and how to address it effectively.
Homeownership often involves managing an escrow account as part of a mortgage, simplifying the payment of property-related expenses. This account, managed by the mortgage lender, collects funds from the homeowner’s monthly mortgage payment to cover anticipated costs like property taxes and homeowners insurance. While intended to provide convenience, funds in this account can be insufficient. This shortfall is known as an escrow shortage.
Defining an Escrow Shortage Amount
An escrow shortage occurs when the balance in a homeowner’s escrow account is insufficient to cover the costs of property taxes and homeowners insurance premiums paid by the lender. This means monthly mortgage payments have fallen short of real expenses. For example, if annual property taxes and insurance total $4,000, but only $3,800 was collected, a $200 shortage exists.
An escrow shortage is identified during a periodic review by the mortgage servicer. This review compares collected funds against actual disbursements for taxes and insurance, usually from the past year. If disbursements exceed collected amounts, or projected future costs are higher, a shortage is determined. An escrow shortage differs from an escrow deficiency, where the account is negative because the lender advanced funds.
Common Reasons for a Shortage
Several factors can contribute to an escrow shortage, often due to increased costs the escrow account covers. A frequent cause is an unexpected rise in property taxes. Local tax authorities may reassess property values or introduce new levies, directly increasing the annual tax burden. When these increases occur, the previous year’s estimated tax amount becomes insufficient.
Increases in homeowners insurance premiums are another common reason for an escrow shortage. Insurance costs can fluctuate due to factors like increased claims in an area, inflation affecting rebuilding costs, or changes in insurer risk assessment. If a homeowner’s insurance premium rises significantly, monthly collections may no longer adequately cover the new, higher annual premium. Initial underestimation of costs at loan origination can also lead to a shortage, especially if the initial tax assessment on a new home considered only land value.
The Escrow Account Analysis Process
Mortgage servicers regularly conduct an escrow account analysis to ensure sufficient funds are collected for property taxes and insurance. This analysis is typically performed annually, reviewing past 12 months’ activity and projecting expenses for the upcoming 12 months. The Real Estate Settlement Procedures Act (RESPA) and its implementing Regulation X require servicers to perform these analyses.
During this process, the servicer compares actual amounts paid for taxes and insurance against collected funds. The analysis also considers a required “cushion,” typically one-sixth (two months) of estimated annual disbursements, to cover unanticipated increases or timing differences. If the analysis reveals the projected balance will fall below this cushion, or if actual disbursements exceeded collections, a shortage is identified. The servicer must provide an annual escrow account statement to the borrower within 30 days of the computation year’s completion, detailing the analysis and any resulting shortage or surplus.
Addressing an Escrow Shortage
Once an escrow shortage is identified, the mortgage servicer communicates this to the homeowner via an annual escrow analysis statement or letter. This communication specifies the shortage and outlines resolution options. Homeowners have choices in addressing the deficit.
One option is to make a lump-sum payment to cover the shortage. This payment is directly applied to the escrow account, bringing the balance to the required level. Alternatively, homeowners can spread the shortage across future monthly mortgage payments. This is often divided equally over 12 months, increasing each monthly payment until repaid. While a lump sum payment prevents an increase in monthly payments due to the shortage, the overall mortgage payment might still rise if property taxes or insurance premiums have increased.