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What Is An Escrow Shortage?

Kevin Graham8-minute read
August 13, 2021

Escrow accounts are among the items that give home buyers and even seasoned homeowners the most confusion when it comes to mortgage payments. At its most basic, an escrow account enables you to make the payments toward your taxes and insurance in monthly installments rather than having to make a big outlay when these bills come due. An escrow account provides a level of convenience because you don’t need to plan for big bills for taxes or homeowner’s insurance.

However, things like property taxes and insurance change periodically as costs fluctuate. When this happens, you could end up with an escrow shortage. This article will go over shortages so you can understand what’s happening. Then we’ll go over options for taking care of a shortage. But first, let’s get back to basics.

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What’s Included In An Escrow Account?

An escrow account is meant to help you break down the cost of various items associated with homeownership into manageable monthly payments. There are several items that are typically included in an escrow account. You may be more familiar with some items that are in an escrow account than others:

  • Hazard Insurance: Your payment for homeowners insurance is included in an escrow account. Fire and wind insurance may also be included in this category. This covers damage to your property. If there is ever damage, your lender wants to make sure you have enough coverage that the property could be repaired or rebuilt to retain at least its original value. Depending on the coverage and what you’re paying for, you may also have some personal liability and personal property protection.
  • Flood Insurance: This form of hazard insurance is common enough to merit its own category. If you’re in a flood zone, you may be required to have flood coverage. The water zones change as weather and environmental patterns evolve, so even if you weren’t required to have flood insurance when you initially bought your home, it might need to be added at some point.
  • Mortgage insurance: If you made a down payment of less than 20%, you’ll end up paying for private mortgage insurance until you reach at least that amount of equity with a conventional loan. FHA and USDA have their own forms of mortgage insurance requirement, usually for the life of the loan.
  • Property taxes: The real estate taxes paid on your property are most often paid out of an escrow account so that they’re in monthly installments.
  • Ground rents:In some cases, you may own your home, but not the land it’s sitting on. If that’s the situation for you, you have a ground rent. The fees for this would be included in your escrow account to be paid to your landlord when the time comes.
  • Special assessments: If you have a recurring special assessment levied by your county or other taxing authority, this is included in your escrow account. It’s important to note that this isn’t necessarily the case if that’s just a one-time fee.
  • Charges that could take first-lien position: Any payment that could take precedence over your mortgage in the event that you default and the property needs to be sold may be included in your escrow account. A good example of this might be loans for solar panels that are installed on your house.

For most people, the items included in an escrow account are property taxes, hazard insurance (including homeowners insurance) and other policies, along with any applicable mortgage insurance.

What’s An Escrow Shortage?

An escrow shortage refers to any time when your escrow balance falls below a minimum required level. We’ll get into how that level is defined later, but for now, what’s important to understand is that you have a shortage anytime the minimum balance isn’t met.

In addition to a shortage, there’s also something called an escrow deficiency. This is when you don’t have enough money in your escrow account to pay for all your escrow items, like taxes and insurance. If that’s the case, you end up with a negative balance in your account and your mortgage lender will advance the difference between what’s in your account and the amount that’s due. You’ll end up paying this back when your next escrow analysis is conducted.

On the other hand, you could end up with an escrow surplus. This occurs when you paid more into your escrow account than you had to in the previous year. This most commonly occurs if your property value has gone down enough to change your tax assessment, or if you switched to a cheaper homeowners insurance policy.

What Causes An Escrow Shortage?

An increase in any of the items in your escrow account can cause you to be short, but for most people, the thing that will cause a shortage is an increase in either your hazard insurance premiums or your property taxes.

If either of these goes up significantly and causes your escrow account balance to fall below a minimum, you’ll have a shortage and you’ll have to pay it off, but before we get into those options, let’s go over how your mortgage lender evaluates the amount that needs to be paid for escrow.

Understanding Escrow Analysis

Counties and other relevant taxing authorities like school districts often reassess your property value for tax purposes once a year. This is the most significant thing that causes changes to your escrow account because they may go up or down every year.

The problem is that different counties do their assessments at different times of the year, so it can often be impossible to sync up the movements of your property taxes exactly with those of your escrow account. Your mortgage servicer – the entity you send your payments to every month – conducts an escrow analysis once per year in order to make sure you have the appropriate amount of money in your escrow account. Within a month or 2 of that analysis, you should get a letter stating whether you have a shortage, paid too much or if it’s in that Goldilocks zone of being just right.

There’s also something known as a cushion. Let’s say your property taxes go up, and while you have enough money to pay them off, it significantly depletes the balance in your escrow account.

Mortgage lenders require you to have a certain cushion in your escrow account, which is generally a specific number of months’ worth of escrow payments. A good general guideline for Rocket Mortgage®1 clients is to expect to need at least 2 months’ worth of escrow payments. Some states have different guidelines in accordance with local regulations, so talk to your Home Loan Expert. In any case, if you fall below the cushion, you’ll be required to make up the difference between the existing balance in your account and the minimum balance.

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What Happens If My Escrow Account Is Short?

If you have a shortage in your escrow account, you’ll have to pay it back. When your escrow analysis is completed and your servicer sends you the report, you’ll have a couple of options:

  • Pay off the shortage in full: You can make a one-time payment to your mortgage company that would cover paying back any existing deficiency and/or getting you back up to the required minimum balance based on your new monthly escrow payment. This lump sum payment is applied directly to your escrow account.
  • Pay off the shortage over the next 12 months: If you don’t want to or can’t pay your shortage in a lump sum, you have the option of spreading the payments out over the next year in order to pay it back over time.

You should also know that even if you pay off your shortage in full, your monthly escrow payment will often increase. The reason for this is that your shortage is usually caused by an increase in the amount due for taxes and/or hazard insurance. The amount due for escrow will change to reflect the new amounts due.

Can You Pay Your Escrow Shortage With A Credit Card?

Policies will vary depending on who your mortgage servicer is, but many of them, including Rocket Mortgage®, won’t allow you to make mortgage or escrow payments with a credit card.

The primary reason for this is that mortgage and escrow payments deal with large amounts of money. A credit card finance charge of 2% – 3% on a mortgage payment adds up to a lot more than it does if you charge a cup of coffee in the morning.

How Can I Avoid An Escrow Shortage?

While you may not have a ton of control over your bills for property taxes and mortgage insurance, there are a couple of things you can do to minimize the chances of being surprised by a large escrow shortage or deficiency.

The first thing to be aware of is making the right moves when switching homeowners insurance policies. If done incorrectly, you can easily end up with a shortage or deficiency in your escrow account even if the new policy you’re switching to is less expensive. This is because homeowners insurance premiums are paid in advance for the time period that they cover when you switch. Let’s go through an example.

Let’s say you’ve decided to switch policies 9 months into a yearlong policy term. You’ll be getting a check back from your previous carrier for the 3 months remaining on the policy. While this can seem like a windfall, you should immediately send the refund check to your servicer. Otherwise, because the insurance premiums are paid upfront, you’ll end up with a shortage because the lender has essentially paid for two policies ahead of time. Clients serviced by Rocket Mortgage® can find out more about the process of changing homeowners insurance policies.

The second thing you can do if you’re concerned about the possibility of a shortage is make a special payment or portion of your payment that’s specifically earmarked for your escrow account. Some people choose to apply any escrow surplus checks they get back to their account in order to try to avoid future shortages.

How Do I Reduce My Escrow Payment?

Escrow accounts are based entirely on things like property taxes and insurance premiums, so you have limited options to lower your escrow payment, but there are some things you can do.

As mentioned above, you can shop around for homeowners insurance coverage. You may be able to find a deal for similar levels of coverage with a different provider. Some providers will also give discounts if you bundle policies together, so that could be worth looking into.

There’s not much you can do to change your taxes, but at the same time, it’s worth a periodic review to check that you are only paying what you owe. Make sure you’re applying for every property tax exemption you might qualify for. Most areas have something called a homestead property tax exemption where you get a discount if the property serves as your primary home. Additionally, there are often tax exemptions available for the disabled or veterans of the U.S. military. If you’re unsure of what might be available in your area, it’s worth talking to your local tax authority. You can also speak with a financial advisor and/or tax preparation professional.

This should help you feel much more able to handle an escrow shortage. If you’re ready to take that newfound confidence and buy or refinance a home, you can do so online through Rocket Mortgage® or give us a call at (888) 980-6716.

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Kevin Graham

Kevin Graham is a Senior Blog Writer for Rocket Companies. He specializes in economics, mortgage qualification and personal finance topics. As someone with cerebral palsy spastic quadriplegia that requires the use of a wheelchair, he also takes on articles around modifying your home for physical challenges and smart home tech. Kevin has a BA in Journalism from Oakland University. Prior to joining Rocket Mortgage he freelanced for various newspapers in the Metro Detroit area.