By Alena Kairys
Dec 11, 2021If your escrow statement mentions a shortage, it’s normal to be confused or feel anxious. Before you start panicking, learn what an escrow shortage is and how to fix it.
What is an Escrow Account?
To understand what an escrow account is, it is necessary to know what escrow accounts are and how they work. When you close on your new loan an escrow account will likely be established to pay for property taxes, home insurance (includes home owners and flood insurance if property is in flood zone), and sometimes private mortgage insurance (PMI).
An escrow account is established using insurance policies obtained by the homeowner and a property tax bill or tax assessment to calculate how much you will deposit into the account. At closing, the escrow reserve account is established and is normally cushioned by two months. As you make payments, the escrow portion of your payment is deposited into the reserve account so when escrows become due, funds are available to cover those items that are due. The cushion collected at closing serves as an emergency reserve, as well as a required target or minimum balance for the account.
Your loan servicer (who may or may not be your original lender) will take funds from the escrow account to pay escrow items on your behalf. This setup can simplify things for you since you do not have to worry about missing a crucial payment, and it protects the lender’s investment by ensuring your property is insured and clear of liens.
How Does an Escrow Shortage Happen?
Each year, your servicer will perform an escrow analysis to estimate next year’s costs and check to see if there is a shortage, deficiency, or surplus on your account. They will then send you an escrow account statement that includes how much you paid last year, current payments, a cost breakdown, balance, and a prediction of next year’s costs. If the amount in your account is projected to fall below the required target balance, there will be a shortage.
Your monthly payment factors in property tax and home insurance, but neither of those elements stay constant. If your property is reassessed at a higher value or your insurance rates increase, you will have to pay more from your escrow account. Since there is no timeframe to when your county will reexamine your home, a tax increase can be unexpected. Also, if you’ve bought a new construction home, you can expect the property tax to increase significantly, as there is now a structure on the land.
What Does an Escrow Shortage Mean for You?
If you find your escrow account has a shortage, you will have to pay to make up the difference. When you notice there is a shortage, you can pay it off completely or have your loan servicer roll the amount into your mortgage payment over 12 months.
If you chose to pay the shortage in full, your mortgage payment may only increase by 1/12th of the increase in the current year annual escrow figures.
If you chose to make the shortage payment over 12 months, you will be making a higher payment for the next 12 months. This payment will include 1/12th of the escrow shortage (created from higher insurance and tax payments prior year) and 1/12th increase of the current year annual escrow figures.
Once your shortage is cured from making the 12-months of higher payments, you should see a drop in the mortgage payment. Your next payment should only increase by 1/12th of the increase in the annual escrow figures.
Even though you do not have much control over how much your property is taxed, when it comes to your insurance policies you can try lowering policy costs by shopping around for a lower plan. You may be able to find a less expensive policy without sacrificing coverage.
If you receive a surplus check from your servicer, you should contact them for explanation to confirm why you are receiving the check. The surplus check could simply come from the new construction home you bought which the county has not fully assessed, and the servicer had to pay the lower land only taxes. It could also be from a tax due date erroneously rolled over to next year by your current servicer.
You may consider putting it in the bank or redepositing it into your escrow account in case of an unexpected increase or possibly find it was sent to you in error. If you can, always have emergency savings on hand in case there is a surprise escrow shortage and track your insurance rates, tax assessment, and escrow statement so you can prepare accordingly.
Although it is not ideal to have a shortage in your escrow account, paying the difference will prevent many other home problems in the future. Though price increases may be unexpected, you can prepare a safety net for yourself by adding more funds to your escrow account and staying informed of your property expenses. Always communicate with your loan servicer if you have any questions regarding your escrow account. Any time you receive county tax bills or notices, notices from your insurance agents, or have changed insurance agencies you should always contact your servicer and provide the documentation and information.
If you have any questions about escrow shortages, contact one of our licensed Mortgage Loan Originators. If you are ready to begin the home buying process, click here to get started!
These blogs are for informational purposes only. Make sure you understand the features associated with the loan program you choose, and that it meets your unique financial needs. Subject to Debt-to-Income and Underwriting requirements. This is not a credit decision or a commitment to lend. Eligibility is subject to completion of an application and verification of home ownership, occupancy, title, income, employment, credit, home value, collateral, and underwriting requirements. Not all programs are available in all areas. Offers may vary and are subject to change at any time without notice. Should you have any questions about the information provided, please contact us.