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When you buy a home, your lender usually sets up an escrow account to hold the funds you'll use to pay your taxes and homeowners insurance. Each month, your mortgage servicer directs a portion of your mortgage payment and deposits it in your escrow account to ensure there's enough to cover these costs when they become due.
In certain circumstances, you could end up with an escrow shortage. An escrow shortage occurs when there's not enough money in your escrow account to pay your estimated taxes and insurance in the future.
Here's what you need to know about escrow shortages, including what causes them, how to resolve them and how they may impact your monthly mortgage payments.
What Is an Escrow Shortage?
An escrow shortage means the funds in your escrow account don't meet the minimum requirement. Even if there's money in the escrow account, it's considered short if there isn't enough to cover your property tax and insurance bills.
It's also possible to have an escrow deficiency. Unlike an escrow shortage, in which your account may hold money, an escrow deficiency means your account has a negative balance. A deficiency can occur if there's a shortage in your escrow account, and your lender must pay the difference for your tax and insurance bills.
Just as your account can have a shortage, it can also have an escrow surplus. For example, your escrow account could have extra funds if your tax or insurance costs turn out to be lower than expected. Many lenders leave the surplus in your account if it falls below a specific amount, like $50. If the surplus exceeds the set amount, they'll send you a refund check.
What Causes an Escrow Shortage?
Let's look at a common scenario that often leads borrowers to have an escrow shortage. Say you pay $2,000 per year in property taxes. If you spread that amount over 12 months, roughly $167 ($2,000 / 12 = $166.66) of your monthly mortgage payment must be directed to your escrow account for your annual tax bill.
Meanwhile, if your homeowners insurance bill comes to $1,200 per year, another $100 ($1,200 / 12 = $100) should go to your escrow account each month to pay your insurance costs. If your monthly mortgage payment is $1,500, then $1,233 will cover your principal and interest payment, with the remaining $267 being placed in your escrow account to cover your future tax and insurance costs.
But what happens if your property taxes and insurance costs rise? Let's say your property taxes rise to $3,000 per year, and your annual homeowners insurance bill increases to $1,500. These figures represent a $1,300 overall cost increase, which can leave you with an escrow shortage.
You can typically satisfy this shortage with a lump sum payment to your lender or by spreading the shortage in payments over the year.
How to Fix an Escrow Shortage
After your mortgage servicer completes the escrow analysis, they'll send you a report. If there's an escrow shortage, you are responsible for covering that amount and usually have three options to do so.
1. Pay the Full Shortage Now
If you choose this route, you'll pay off the entire shortage in one lump-sum payment to balance your escrow account. Keep in mind, however, even if you pay the shortage, your monthly mortgage payment may still increase if your property tax or insurance costs have increased.
2. Pay the Shortage Over the Next 12 Months
Instead of paying for the shortage upfront with one payment, you can spread it out over your monthly payments for the next year. Essentially, you divide the shortage amount by 12 and add the resulting figure to your monthly mortgage payments. This option may make sense if you can't pay the full shortage amount upfront.
3. Pay Part of the Shortage Now, and the Rest Over the Next 12 Months
This option combines the advantages of the previous two choices. It may be more affordable since you can make a partial payment upfront to reduce your escrow shortage. Then, you can spread the remaining balance over the monthly mortgage payments for the following year.
How to Avoid an Escrow Shortage
There may be little you can do to avoid an escrow shortage, but staying on top of notices about changes to your property taxes and homeowners insurance rates can help you stay prepared for the extra costs. Understanding how your property taxes are calculated can also help you anticipate changes so you can budget accordingly.
If you know that taxes and insurance costs are rising, it may be wise to add some extra money to your escrow account ahead of time for the anticipated higher bills. Similarly, if your expenses tend to increase every year, consider making higher monthly escrow payments.
The Bottom Line
If you have a mortgage, you likely have an escrow account that holds a portion of your monthly mortgage payment to pay for property taxes and insurance. If these costs go up, you might have an escrow shortage that prevents the payment of those bills. You can fix the escrow shortage by paying the entire shortage amount in one lump sum, spreading it out in payments over a year or doing a mix of both.
Just as staying on top of your mortgage and escrow payments is essential for your financial health, free credit monitoring from Experian can help you maintain your credit health. You'll receive alerts about changes to your credit report and notifications about balance and credit utilization updates to help you keep track of your accounts and overall credit.