Escrow Shortage: What It Is And How To Avoid It

An escrow account set up in connection with a mortgage lets you make payments toward your taxes and insurance in monthly installments rather than making a big lump-sum payment when these bills come due. However, this type of account has the potential to be confusing for new home buyers and seasoned homeowners alike because the amount you owe in property taxes and homeowners insurance premiums can fluctuate.

When this happens, you could end up with an escrow shortage. Before delving deeper into escrow shortages, though, let’s first more thoroughly explore what an escrow account is and what it does. Then, we’ll take a closer look at escrow shortages and how it’s possible to avoid having one.

Escrow Shortage Meaning

An escrow shortage is when your escrow balance falls below a minimum required level. More details later on how that level is defined, but just know for right now that you have a shortage anytime the minimum balance isn’t met.

Along with an escrow shortage, it’s important to become familiar with what’s known as an escrow deficiency and an escrow surplus. An escrow deficiency is when you don’t have enough money in your escrow account to pay for all your escrow items, such as taxes and insurance. If that’s the case, you end up with a negative balance in your account and your mortgage lender will advance the difference between what’s in your account and the amount that’s due. You’ll pay this back when your next escrow analysis is conducted.

An escrow surplus occurs when you paid more into your escrow account than it turns out you needed to pay in the previous year. This most commonly occurs if your property value has gone down enough to change your tax assessment, or if you switched to a cheaper homeowners insurance policy.

What Causes An Escrow Shortage?

An increase in any of the items in your escrow account can cause you to come up short, but shortages most often happen due to an increase in your homeowners insurance premiums or your property taxes.

If either goes up significantly and causes your escrow account balance to fall below a minimum, you’ll have a shortage that you must pay off. However, before delving deeper into your payment options, it’s paramount to understand how your mortgage lender evaluates the amount you’ll need to pay for escrow.

An Escrow Shortage In Action

For the sake of an example, let’s suppose your monthly mortgage payment is $1,600. Of that, $400 covers your escrow broken down as follows:

• $250 per month for property taxes ($3,000 per year / 12 months)
• $150 per month for homeowners insurance ($1,800 per year / 12 months)

Now suppose you just received your annual escrow analysis, which revealed that your property taxes went up to $3,600 per year.

You were paying $400 per month for escrow, when – in reality – you needed to be setting aside $450 ($3,600 / 12, added to the $150 monthly insurance payment) to reflect this tax increase. Now, you have an escrow shortage and must pay your lender the shortage amount of $600.

Your monthly payment will also increase by $50, meaning your mortgage payment will now be $1,650.

What Happens If My Escrow Account Is Short?

Paying an escrow shortage is possible in one of multiple ways. When your escrow analysis is completed and your servicer sends you the report, you’ll have these escrow shortage options:

• Pay off the shortage in full. You can make a one-time escrow shortage payment to your mortgage company to cover any existing deficiency and/or get back up to the required minimum balance based on your new monthly escrow payment. This lump-sum payment is applied directly to your escrow account.
• Pay off the shortage over the next 12 months. If you don’t want to or can’t pay your shortage in a lump sum, you can spread the payments out over the next year instead.

Bear in mind that even if you pay off your shortage in full, your monthly escrow payment will often increase. That’s because your shortage is usually caused by an increase in the amount due for taxes and/or homeowners insurance. The amount due for escrow will change to reflect the new amounts due for items covered by the money in your escrow account.

Can You Pay Your Escrow Shortage With A Credit Card?

Policies vary by mortgage servicer, but many servicers – including Rocket Mortgage^® – won’t allow you to pay an escrow shortage with a credit card.

That’s primarily because mortgage and escrow payments deal with large amounts of money. A credit card finance charge of 2% – 3% on a mortgage payment adds up to a lot more than a charge you put on a credit card for a cup of coffee in the morning.

How To Avoid An Escrow Shortage

While you may not have much control over your property taxes, homeowners insurance and mortgage insurance (if you’re required to pay it), you can take a couple of actions to minimize the chances of being surprised by a large escrow shortage or deficiency. Specifically:

• Be aware when switching homeowners insurance policies. If you change homeowners insurance policies in the middle of a policy term but don’t send your refund check to your servicer, you can end up with a shortage or deficiency in your escrow account even if the new policy you’re switching to is less expensive. This is because homeowners insurance premiums are paid in advance for the time period they cover when you switch.
• Make a payment that’s specifically earmarked for your escrow account. Some people choose to apply any escrow surplus checks they get back to their account in an attempt to avoid future shortages.

Ways To Reduce Your Escrow Payment

Because escrow accounts are based on property taxes, insurance premiums and perhaps other variable costs, you’ll have few options for lowering your escrow payment. That said, here are some steps you can take.

Shop Around For Homeowners Insurance Coverage

You may be able to find a deal for a similar level of coverage with a different provider. Some providers will also give discounts if you bundle policies together, which is an option you should probably look into.

Review Your Taxes

It’s worth a periodic review to make sure that you’re only paying what you owe in taxes. Verify that you’re applying for every property tax exemption you might qualify for. Most areas have something called a homestead property tax exemption, which offers a discount if the property serves as your primary home.

Additionally, tax exemptions are often available for the disabled or veterans of the U.S. military. If you’re unsure of this availability in your area, it’s worth contacting your local tax authority, a financial advisor or a tax preparation professional.

The Bottom Line

You can’t control an increase in your property taxes or homeowners insurance, but being as prepared as possible for one can potentially help you avoid an escrow shortage.

Understanding escrow is just one piece of the puzzle that is homeownership, though. If you’re interested in buying or refinancing a home, start the approval process today with Rocket Mortgage.