What in the world is an escrow shortage?

When you buy a home, your mortgage payment is one number, yet even if your interest rate is fixed, the cost to own a home isn’t static. Property taxes rise and fall with your home’s value. Homeowners insurance premiums typically go up over time with replacement cost. If you have an escrow account, these are part of your payment.

We’ll answer many questions in this article, including the one that probably led you here: What is an escrow shortage? While that’s a great one, let’s start with something more foundational.

What is an escrow account?

An escrow account is an account that holds the funds you need to pay your property taxes, homeowners insurance, and, if applicable, mortgage insurance. Managed by your servicer, it’s a holding account that contains funds set aside every month so you don’t have to make one big payment.

By consolidating these payments into your monthly mortgage payment, you only pay one bill rather than several bills all due at different times. Your mortgage servicer helps by making sure you have enough money in your account to cover your bills; then when the bills are due, they pay them on your behalf.

What is an escrow shortage?

An escrow shortage is when your mortgage servicer isn’t collecting enough escrow to cover the amount needed for taxes and insurance payments. Money for escrow comes directly from your monthly mortgage payment. How much of the money you pay goes to your escrow account is determined by your yearly escrow analysis.

How often does the escrow account get analyzed?

An escrow analysis is conducted periodically to account for changes in your property taxes and homeowners insurance. These are usually conducted annually, but at the beginning of your loan, your servicer may perform an analysis covering a shorter time frame to get you on schedule with the rest of the loans in your state.

After an escrow analysis is conducted, mortgage payments often change due to fluctuations in real estate taxes and homeowners insurance. Your escrowed items are broken out on your mortgage statement. If you have a fixed-rate loan, the portion of the monthly payment going toward principal and interest will never change.

What causes an escrow shortage?

The reason shortages happen is that counties do tax assessments at different times. Because of this, mortgage servicers try to do all the analyses within a state in a given month each year. Payments for Rocket Mortgage^® clients are usually updated 2 months after analysis. A shortage means one or more of these happened:

• An increase in property taxes
• An increase in homeowners insurance premiums
• Changing homeowners insurance policies without sending the refund to your mortgage servicer

In dealing with an escrow shortage, clients are often given a couple of options:

• Cover the shortage in a single payment.
• Spread the shortage over the course of the next year by putting an extra amount toward escrow each month.

Clients should be aware that even if they pay off the shortage in a lump sum, their mortgage payment is still going to change to account for the new higher cost of taxes and insurance.

Escrow shortage example

To give you an idea of how shortages happen, consider the following changes happening between escrow analyses

What’s the difference between an escrow shortage and an escrow deficiency?

An escrow shortage happens when an increase in your property taxes or homeowners insurance causes a lower balance in your escrow account than your servicer was projecting based on your prior payments for these items. An escrow deficiency happens if the balance in your escrow account actually goes negative.

As a practical matter, there’s no difference for clients because mortgage servicers will advance the money that you’re missing due to deficiency. You pay back the shortage and start paying at the new rate when your escrow is next analyzed. This is done once a year. You’re given a new payment to try to avoid future shortages.

Servicers do try to sidestep deficiencies by having you fund a month or two worth of escrow at closing. Home buyers don’t need to worry about this escrow cushion because they usually get it back when the loan is paid off. You may be able to limit refinancing impact by rolling escrow into the new loan to lower your closing costs.

Minimizing the impact of escrow shortages

Because it’s often a function of timing, there may be an inevitability to escrow shortages, but there are ways to mitigate the impact.

Pay attention to tax and insurance increases

The first step is awareness. When there’s a property tax increase, the tax assessor for the county is likely to mail you something. You can often look up the tax rates and bills through a county or parish website.

You can also find resources there if you need to dispute an increase either because you disagree with the value or believe exemptions aren’t being appropriately applied.

If your homeowners insurance provider intends to increase your rates, you should also get a notification from them as well.

Regularly shop around for homeowners insurance

Another thing to do is regularly look at different homeowners insurance providers to make sure you’re getting the best level of coverage for your money. If you can get an equivalent level of coverage for less, changing homeowners insurance policies could save money on your monthly mortgage payment. But make sure to do it right:

When you cancel your initial homeowners insurance policy after the new coverage goes into effect, you have to notify your mortgage servicer so that the policy details are on file. Your mortgage lender is named on your insurance policy because they have an interest in the value of your home if it gets damaged.

Rocket Mortgage^® clients can update their coverage info online or give us a call at (800) 508-0944 for more info.

You should also send the refund check from your prior carrier back to your mortgage lender. Homeowners insurance policies are paid upfront, so sending in the refund check for your previous policy can help avoid escrow shortages.     

Set aside cash to cover escrow account shortfalls

When you know your taxes or homeowners insurance are increasing, you can set additional money aside once you figure out what the increase is going to be to pay the shortage all at once if you want.

Alternatively, you might choose to spread the shortage over 12 months, but you have the money ready. You might find you could make significant interest on the money while it sits in a high-yield savings account.

Can escrow shortage payments affect mortgage rates?

Escrow shortages don’t affect your mortgage rate or any other term of your home loan. But changes to your taxes and insurance can increase your monthly mortgage payment if you have an escrow account.

Why is the escrow shortage payment higher than the actual shortage amount?

The payment for your escrow shortage may be higher than the actual shortage amount because your servicer will be trying to rebuild the cushion to prevent an escrow deficiency in the future. Your payment will be for the shortage, plus up to a couple months of the new monthly payment.

Let’s say your property taxes go from $800 a year to $1,160 per year. That would mean a shortage of $360 if nothing changed with your homeowners insurance.

Under this scenario, your shortage amount would be $420, which is the shortage plus a 2-month cushion. Your escrow payment would also go up $30 per month to account for the tax increase going forward.

The bottom line: Escrow shortages are a manageable situation

Escrow shortages occur because your mortgage servicer hasn’t collected the correct amount monthly to pay your property taxes, mortgage insurance, and homeowners insurance. The culprit for this is often a delay between changes to your homeowners policy or tax bill and your escrow analysis.

You can mitigate these issues by always sending the refund to your mortgage servicer, and setting aside extra money when you find out about tax increases. For even more information on managing your mortgage, check out the rest of our Servicing section at the Rocket Mortgage® learning center. If you’re ready to buy home you can also begin your loan application today.