By Alena KairysDec 11, 2021
If 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’s necessary to know what escrow accounts are and how they work. When you purchase a home, you may want to open an escrow account with the new lender or servicer to pay for property taxes, home insurance, and sometimes private mortgage insurance (PMI). If the property you are purchasing is in a flood zone, flood insurance is required.
Your lender will use your insurance information and last year’s or current property tax assessment to calculate how much you will deposit into the account. At closing, you’ll need to pay several months’ worth of escrow payments based on the due dates for both insurance and taxes and also will be required to meet a two month escrow cushion requirement. You will be adding more escrow funds in the escrow account from your monthly mortgage payment. The cushion 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 account to pay these fees on your behalf. This setup can simplify things for you since you don’t 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’ll 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’ll have to pay more from your escrow account. Since there’s 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’s 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 pay the shortage in full upfront, your mortgage payment may only increase by 1/12th of the increase in the annual escrow figures.
If you chose to make the shortage payment over 12 months, you will be making higher payments 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 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 don’t have much control over how much your property is taxed, you can try lowering your home insurance policy by shopping around for a lower plan. You may be able to find a less expensive policy without sacrificing coverage.
In some situations, you might receive a surplus check from your servicer. Consider putting it in the bank or redepositing it into your escrow account in case of an unexpected increase. You should always have emergency savings on hand in case there’s a surprise shortage and keep tabs on your insurance rates, tax assessment, and escrow statement so you can prepare accordingly.
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 initially pay the lower land-only taxes or because of a lower insurance policy provided to the servicer.
Although it’s 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.
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!
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