Escrow Shortage: What Is It and How Do You Pay It Off?
Updated July 26, 2021
Reading time: 6 minutes
Your home is one of the most expensive purchases you’ll ever make. The costs of buying a house, paired with additional home expenses like property taxes and home insurance, add up pretty quickly. The good news is that you likely don’t need to manage all of these expenses on your own.
Whether you’re still in the process of closing on your new home or you’ve already started making mortgage payments, you’ve probably heard your mortgage lender discussing escrow accounts. These are accounts set up to either hold your good-faith deposit until you close on your home or manage your homeowners insurance and property tax payments.
But what happens if you find yourself in an escrow shortage? How do escrow shortages occur? And what’s the best way to pay your escrow shortage off?
Escrow accounts—and escrow shortages—can seem complicated. But with Insurify, they don’t have to be confusing. Keep reading for our full guide on escrow shortage to learn how it happens and how to pay it so you can get back to enjoying your home in no time.
Before tackling your escrow shortage head-on, it’s important to know what escrow is and to understand the difference between the two types of escrow accounts.
Escrow is a legal arrangement where an outside party—in this case, a mortgage lender or loan servicer—holds a large sum of money until a specific condition has been achieved. The specific condition you need to achieve before your escrow account can be closed depends on which type of escrow account you have.
The first type of escrow account is set up when you first purchase or refinance your home.
Before closing on a home, most homebuyers make a good-faith deposit (also known as “earnest money”). Since you make this payment before you close on your new home, an escrow account is created to protect the deposit, the home buyer, and the seller until the purchasing process is complete. Escrow accounts created during the home-buying process essentially hold onto earnest money while it is neither yours nor the sellers.
Once you close on your home, the deposit will be used toward your down payment. If you don’t end up purchasing the home, the real estate agency or seller will use the deposit to cover the costs associated with relisting the home. The funds in this type of escrow account may stay there after closing for various reasons based on your agreement with the seller. If you are building a new home rather than purchasing a home from a real estate agent, funds may remain in your escrow account until you finish signing off on all the work to be completed for your new home.
The second type of escrow account is set up to be used for the duration of your home loan, rather than during the purchasing process.
Your mortgage company or home loan servicer may require you to have an escrow account to cover the additional costs of owning a home, aside from the cost of your mortgage loan. These additional costs may include your homeowners insurance and any additional insurance policies you need (like flood or earthquake insurance), real estate taxes or ground rent (depending on whether you own the land), and private mortgage insurance (if you are required to hold a PMI policy).
This means that when you make your monthly mortgage payment, it will include your mortgage rate and these additional costs, like property taxes and home insurance. Your mortgage company sets aside the portion of your payment intended for paying your home insurance company and additional monthly payments and places these funds into your escrow account.
The mortgage lender then takes this money and makes disbursements to pay for your homeowners insurance premiums and real estate taxes. This makes the payment process simpler for the homeowner, since you don’t need to worry about making your insurance payments or calculating your property or county taxes. After you send your monthly mortgage payment to your mortgage lender, your work is done.
Escrow accounts that last for the duration of your mortgage help take the guesswork out of making monthly payments for your homeowners insurance and property taxes. Mortgage companies typically require these escrow accounts to hold two months’ worth of payments as a cushion, but these costs can change unexpectedly based on factors like your property value and credit score.
If any of your costs, also referred to as “escrow,” increase at any time, you will be left with an escrow account shortage. This means that your escrow account may still have a positive balance (thanks to that required two-month cushion), but it does not have enough funds to cover the increased tax or insurance rate in the future. These changes will increase your monthly escrow payments, leaving you responsible for covering the shortage amount.
The minimum balance you need in your escrow account changes every year—mostly due to property tax or home insurance rate increases. For this reason, lenders conduct an escrow analysis once every 12-month period to make sure they’re taking enough money from your monthly mortgage payments to hold in your escrow account. This analysis is based on the estimated costs of your home insurance and property tax assessment for the next year.
If your mortgage lender’s escrow analysis statement says that your escrow account balance is too high—meaning they took out too much money from your mortgage payments in the previous year—they will refund you the additional money. But if your mortgage lender calculates that your escrow account balance is too low—meaning the lender did not take enough money from your mortgage payments to cover your insurance bills and tax bills, likely because of an increase in your rates—you have what is known as an escrow deficiency. This means that you currently have a negative escrow account balance. This is different from an escrow shortage, which implies that you will have a negative balance in the future if you do not increase your monthly escrow payments.
Escrow shortages occur any time your escrow account balance doesn’t contain sufficient funds to cover an increase in your escrow costs. An escrow deficiency, on the other hand, means that your escrow account has a negative balance, and it only occurs following your mortgage lender’s annual escrow analysis. In either case, you will need to pay off the negative balance or the increase in your escrow account’s minimum balance.
If you find yourself in the case of an escrow shortage but have not yet reached a negative escrow account balance, you will need to pay the difference between your current account balance and the new monthly escrow payment amount. Most mortgage lenders require home buyers to have roughly two months’ worth of escrow payments in their accounts.
Whether you find yourself facing escrow shortage or an escrow deficiency, there are generally two options for escrow shortage payments. You can make either one lump-sum payment of the escrow shortage balance or monthly payments over a 12-month period. The option you choose simply depends on the amount you owe and your current financial situation.
If you can afford to pay your escrow shortage in one lump sum, it’s important to note that your monthly escrow payment amount will likely still increase due to the increase in your service costs, whether it be your property taxes or insurance rates.
While you can’t change your local property tax rates to cut down on your escrow payments, there are still ways to minimize your monthly payment costs.
The easiest way to do this is to shop around for cheap homeowners insurance. You can compare homeowners insurance options to see if you could get a better homeowners insurance rate with a different company or policy.
Paying off an escrow shortage can seem like a daunting task. Insurify answered some of homeowners’ most frequently asked questions about escrow shortages so you can decide what the best escrow payment option is for you.
Escrow shortages happen when your escrow costs (typically home insurance or property taxes) increase. You can face an escrow shortage even if you still have funds in your escrow account, and you will be responsible for paying the newly increased monthly escrow balance or rate.
Whether you pay your escrow shortage in full or in monthly payments doesn’t ultimately affect your escrow shortage balance for better or worse. As long as you make the minimum payment that your lender requires, you’ll be in the clear. If you do choose to pay your escrow shortage in full, keep in mind that your monthly escrow payments will likely still increase due to the increase of your homeowners insurance rates or property tax expenses.
In short, probably not, and even if you can, it’s probably not the best option. Some mortgage lenders won’t allow you to pay your escrow shortage with a credit card at all. For those lenders that do accept credit card payments, paying off your escrow shortage in one lump sum with a credit card will probably end up being more expensive in the long run. If you are concerned about affording your escrow shortage payments, the better option is to pay off your escrow shortage monthly with your mortgage lender. This way, you can pay off the debt over a longer period of time, rather than draining all of your financial resources at once. And you won’t need to incur additional credit card fees or interest rates.
Monthly escrow payments are the combination of your homeowners insurance rate, your property taxes, and many additional costs associated with owning your home (like private mortgage insurance). Since many mortgage lenders require homeowners to have at least two months’ worth of these costs in an escrow account, monthly payments to cover these costs can get pretty pricey. But the rates associated with property taxes are out of your hands, so the best way to save on high monthly escrow payments is to shop around for a cheaper home insurance policy.