An escrow shortage occurs when there are insufficient funds in your escrow account to pay for insurance and property taxes. There are many reasons why an escrow shortage may occur, which include everything from an unexpected increase in insurance costs or property taxes to the insurance company being changed while the annual escrow cycle is ongoing.
Most homeowners in the U.S. have an escrow account that’s tied to their mortgage. While you may understand what escrow is, the majority of homeowners don’t know about potential escrow shortages and overages. When introducing these terms into the mix, things can become complicated. Before delving into escrow shortages, you might need a refresher on what an escrow account is.
This type of account holds all of the funds that are required for making annual homeowners insurance payments and paying property taxes. You won’t be able to manage this account directly, which is why you may find that the account is short of funds without any forewarning. Your escrow account will hold your funds until they are are withdrawn each month to pay your insurance bills and taxes.
Both of these payments are usually tied to your monthly mortgage payment, which allows you to pay a single bill as opposed to several bills at different times of the month. Escrow shortages are very common but can be frustrating to deal with. By understanding more about what escrow shortages are, you should be able to prevent them and resolve them whenever they do occur. This guide offers a comprehensive overview of escrow shortages and what they mean for homeowners.
What is an Escrow Surplus?
Along with an escrow shortage, it’s also possible for your escrow account to have a surplus of funds. Once the year comes to an end, your lender should give you a disclosure statement. This statement will list every activity that occurred in your escrow account alongside your final balance. Along with this basic information about previous payments, the statement will also include some details about the payments you must make over the next year.
Keep in mind that escrow payments change over time since insurance rates and taxes tend to fluctuate. In most cases, costs will increase. However, there are times when a decrease may occur. In the event that your home has a lower assessed value when the next years rolls around, your insurance rates and tax rates would drop accordingly. It’s also possible to reduce your required payments by making home improvements, which could lead to your insurance provider giving you a discount.
If your escrow account balance indicates a positive amount at the end of the year, your lender has two separate options at their disposal. If the balance is higher than $50, a refund must be issued immediately, which will result in you being sent a check. When the balance is lower than $50, your lender must apply these funds as a credit for the following year’s payments. Once this balance is applied to your escrow payments, each monthly mortgage payment should dip by several dollars.
Make sure that you take a look at your escrow statement to compare the information to your total payments as well as the insurance and property tax bills that you received. If you notice an error or weren’t provided with a refund that you’re owed, you should reach out to your lender as soon as possible to correct the issue.
Escrow and Where Escrow Funds Come From
To fully understand what an escrow shortage is and how it occurs, you should have a better understanding of what escrow is and where the funds comes from. Most homeowners who are approved for a mortgage loan will open an escrow account once the lender begins the underwriting process. Think of escrow accounts like savings accounts. The main difference is that your lender will manage your escrow account for you.
When you make a monthly mortgage payment, your mortgage lender will send a small portion of this payment to your escrow account to cover the insurance and tax payments that you owe. Escrow is considered to be a legal agreement that involves a third party controlling funds until certain conditions have been met by the other two parties. You can view escrow as a mediator who keeps risk low while a real estate transaction is ongoing.
Keep in mind that you will likely need to place a small amount of money into this escrow account before you’ve purchased the home to indicate to the lender and homeowner that you fully intend to go through with the purchase. These funds will then be used to pay off your taxes and homeowners insurance payments once the sale is closed and the purchase goes through.
An escrow account can be managed by an escrow company, an escrow officer, or the mortgage servicer. Your real estate agent will likely create this account for you. Even though escrow accounts can seem complicated, they are able to simplify the process of paying for homeowners insurance and property taxes. By placing these fees into the monthly mortgage payments you’ll be expected to pay, you only need to focus on making a single payment.
Repercussions of an Escrow Shortage
If you find that there isn’t enough money in your escrow account at the end of the year, this indicates that an escrow shortage has occurred and that your balance is in the negative. Once you receive your annual escrow report, there are several options available to you on how to handle the shortage.
First, you could pay the shortage off in full, which involves making a single payment to your mortgage provider that pays back all of the money you owe and ensures that you have enough funds in your account to meet the minimum required balance.
You could also pay off this shortage over a 12-month period. In the event that you don’t want to pay back the entire shortage in a single payment, you can choose to spread this payment over the entire year, which alleviates some of the burden.
Even if you choose to pay the entire shortage off in a lump sum payment, the monthly escrow payment you owe could still increase. Shortages are typically caused by the costs of homeowners insurance or taxes increasing. While you may repay what you owe, these increased costs still remain and must be paid each month.
If you’re thinking about paying the shortage with your credit card, most lenders don’t allow shortage payments to be made with a card. Escrow and mortgage payments involve a considerable sum of money. Credit cards come with high finance charges of 2-3%, which can add up when making a mortgage payment. Many homeowners choose to have these funds taken directly out of their checking or savings account.
How to Avoid an Escrow Shortage
It’s practically impossible to avoid an escrow shortage since you can’t accurately predict how your taxes or insurance payments will increase. However, there are several steps you can taken to reduce the possibility of an escrow shortage.
Take Preventive Measures
One option available to you is to set aside some extra savings in the event that an escrow shortage occurs. If you find that your monthly payments have increased because of this shortage, having access to additional savings should help you make these payments without issue.
You should also try to pay close attention to your escrow account to effectively predict when or if your balance will drop too low to cover the monthly fees. Make sure that you read any letters or information you receive from the city pertaining to updated tax info. Your insurance provider may also send you letters about your monthly payments. Reading these letters immediately after receiving them allows you to plan for an escrow shortage.
Reduce Escrow Payment
You may be able to lower the possibility of a shortage by reducing the costs of your homeowners insurance or property taxes. Since your escrow payment is directly tied to these fees, reducing them can help you avoid a shortage. If you believe that your property taxes should be lower, you can dispute these taxes or check for any potential tax exemptions. If any of these options succeed, your escrow payment would drop. Consider shopping for more affordable insurance policies from different providers.
Remove the Possibility of an Escrow Shortage Altogether
Another option at your disposal involves getting rid of the potential for an escrow shortage altogether. You could avoid making escrow payments every month by paying your own insurance payments and taxes instead. Keep in mind, however, that this doesn’t reduce the amount of money that you owe. Even though your monthly mortgage payments will drop by a considerable amount, you’ll receive separate bills for your insurance payments and property taxes.
You could get rid of your escrow account by refinancing your mortgage. However, the majority of states will require you to have a high down payment or equity amount before you can consider getting rid of these fees. While avoiding escrow payments might seem appealing, escrow can be highly convenient when compared to the alternative.
Escrow accounts are useful tools that allow homeowners to consolidate numerous bills into one monthly payment. Even though an escrow account is useful, having an escrow shortage is always frustrating. The steps detailed above offer some suggestions on how to prevent an escrow shortage. While you can’t accurately predict changes to property taxes, you can take steps to reduce your property taxes or the amount you pay for homeowners insurance.