What is an escrow shortage?

An escrow shortage occurs if your lender’s estimate of your property tax and homeowners insurance bills comes up short, and your account doesn’t have enough funds to cover those bills. Learn more about when and why this happens, and how to resolve it.

Key takeaways:

• An escrow shortage occurs when your escrow account balance falls below the amount needed to cover your property taxes, homeowners insurance, and minimum reserve cushion.
• An escrow shortage can increase your monthly mortgage payment to cover both past shortfalls and higher expected future bills.
• You can pay an escrow shortage in full via a lump sum or spread the shortage over 12 months in equal monthly installments.

What is an escrow account?

An escrow account is a holding account managed by your mortgage lender or servicer to pay property-related expenses on your behalf.

Instead of saving up on your own to pay annual or biannual property tax assessments and homeowners insurance premiums, your servicer collects a portion of these costs as part of your monthly mortgage payment. When those bills are due, the servicer uses your escrow balance to pay the tax or insurance costs directly.

An increase in your property tax or homeowners insurance bills requires your lender to collect more for the escrow account, which will increase your monthly payment even if you have a fixed-rate mortgage.

Rocket Mortgage offers escrow accounts for its clients.

How does an escrow shortage happen?

An escrow shortage happens when your escrow account – sometimes called an impound account – doesn’t have enough money to cover your projected property taxes, homeowners insurance premiums, and the minimum cushion.

Under the Real Estate Settlement Procedures Act (RESPA), lenders can maintain an escrow cushion equal to up to one-sixth (2 months) of the total annual escrow disbursements to guard against unexpected increases in your tax or insurance bills.

Escrow shortage vs. escrow deficiency

An escrow shortage is when our current or projected balance is less than what’s needed to pay upcoming bills and maintain your 2-month cushion.

Escrow deficiency is when you have a negative escrow account balance because your servicer paid a bill that exceeded your available funds. In this case, the servicer advances you the money to cover the bill, but you’ll have to reimburse them.

Escrow shortage vs. escrow surplus

An escrow surplus is when your account balance exceeds the amount required to pay your bills plus the maximum cushion by $50 or more. If your escrow account balance is too high, your servicer must issue an escrow refund check directly to you within 30 days of the analysis.

How often is your escrow account analyzed?

At least once every 12 months, your mortgage servicer must analyze your escrow account to check disbursements against projected expenses. During the review process, the servicer adjusts your monthly payment for the upcoming year based on updated estimates of your tax and insurance bills.

What causes an escrow shortage?

Escrow shortages are caused by changes in local taxes and insurance rates, or timing discrepancies between bill payments and your yearly analysis.

Property tax increases

Local tax assessments or rate increases are the most frequent cause of escrow shortages. If your county assesses your home at a higher value or passes ballot initiatives that raise property tax rates, your total tax bill rises. Your servicer pays this higher bill, leaving a lower remaining balance in your account than planned.

Homeowners insurance premium increases

Insurance providers adjust rates based on inflation, construction costs, regional weather risks, and policy coverage adjustments. When your annual homeowners insurance premium goes up, your servicer needs more money in your escrow account to pay the carrier.

Insurance policy changes and refund checks

If you change homeowners insurance with escrow midyear, your old carrier typically sends you a refund check for the unused portion of your prepaid premium. If you deposit that refund check into your personal account instead of sending it to your mortgage servicer, your escrow account won't have enough money when the new provider's bill is due.

Previous underfunding

Underfunding can happen if taxes or insurance were underestimated when setting up your loan or during the previous analysis. If your monthly contributions weren’t enough to build the cushion throughout the year, your account will reflect a shortage during the next analysis.

How escrow shortages are calculated

Understanding how escrow shortages are calculated helps you better understand your annual statement. Your loan servicer projects your expected tax and insurance expenses for the next 12 months, plus the cushion of up to 2 months of expenses, and compares that total to your projected lowest balance for the coming year.

Review your escrow analysis statement

Every year, you’ll be sent an escrow analysis statement. This document details:

• Your account activity from the previous 12 months.
• Projected tax and insurance payments for the next year.
• Your minimum monthly cushion.
• Whether you have an escrow shortage, deficiency, or surplus.

Escrow shortage example

To visualize how an escrow shortage impacts your account and monthly payment, consider this sample breakdown:

In this example, your servicer paid $1,000 more in bills than originally estimated, creating a shortage that you’ll have to pay.

If you chose to spread those expenses out over the next 12 months, it would add $83 to your escrow payment. This would be on top of your monthly escrow cost increasing from $350 a month to $433 a month. Your new total for the next year would be $516 a month.

What are your options for handling an escrow shortage?

When an escrow analysis identifies a shortfall, you’ll have a couple of options available to close the gap.

Pay the shortage in full

You can make a one-time lump-sum payment to pay the shortage in full. Paying the shortage up front covers the past deficit immediately, preventing that specific shortfall amount from being added to your monthly mortgage payments over the next year.

Spread the shortage over 12 months

If paying a lump sum is not feasible, your servicer will spread the shortage over 12 months. The servicer divides your total shortage by 12 and adds that exact amount to your monthly mortgage payment for the upcoming year. You’ll pay this in addition to your escrow fees for the current year.

How paying an escrow shortage affects your monthly payment

A common point of confusion is how paying a shortage affects monthly payment calculations. Many borrowers assume that paying the shortage in full will keep their monthly payment completely unchanged, but that is rarely the case.

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

Your new monthly payment reflects two separate components: paying back the past shortage and funding higher projected costs for the future. Even if you pay the past shortage in full, your monthly payment will still increase if your property taxes or insurance rates increase. That increase is necessary to fund the higher annual bills while maintaining your cushion for the next year.

Can escrow shortage payments affect mortgage rates?

No, escrow shortages never affect your mortgage rate or loan terms, even though they can change your monthly payment. Your interest rate remains fixed or variable, per your original contract. Only the escrow portion of your payment fluctuates to cover third-party taxes and insurance.

How to avoid an escrow shortage

While you can't control property tax increases, you can take steps to avoid escrow shortage surprises.

Pay attention to tax and insurance increases

Review any tax assessment notices and insurance renewal statements when they arrive in the mail. If you notice a substantial property tax increase, you can appeal the assessment with your county tax office before the bill is finalized.

Regularly shop around for homeowners insurance

Compare rates from multiple reputable insurance carriers. If you find a policy offering equivalent coverage at a lower rate, changing homeowners insurance policies can reduce your monthly escrow needs.

Set aside cash to cover escrow account shortfalls

If you anticipate that your taxes or insurance will increase, keep some extra funds on hand. Building a personal reserve gives you the flexibility to pay a shortage in full without disrupting your primary household budget.

Escrow shortage mistakes to avoid

Avoid these common mistakes that lead to unexpected shortfalls:

• Keeping insurance refund checks. When changing providers midyear, always forward any refund check from your prior insurer directly to your mortgage servicer to keep your escrow account balanced.
• Cutting insurance coverage. Don’t reduce your insurance limits drastically just to cut monthly payments if it leaves your home underinsured.
• Ignoring tax assessment notices. Failing to review or contest inflated property tax assessments guarantees higher monthly escrow requirements.

FAQ

Here are answers to common questions about escrow shortages.

Should you pay an escrow shortage in full?

Paying in full prevents your monthly payment from rising by the shortage repayment portion, keeping your payment as low as possible. Spreading the shortage over 12 months is an interest-free way to maintain cash reserves if you prefer liquidity.

What does escrow mean in simple terms?

In simple terms, escrow is a neutral holding account managed by your lender that collects funds monthly to pay your property taxes and homeowners insurance bills when they are due.

Is it normal for escrow to increase every year?

Yes, it is common for escrow payments to increase periodically because property values and municipal tax rates often rise over time, alongside increasing home insurance replacement costs.

Is an escrow shortage my fault?

No, shortages are rarely due to homeowner error. They usually result from rising municipal taxes or insurance premium increases determined by third parties.

The bottom line: Escrow shortages are manageable

While they may seem unsettling, escrow shortages are a normal and manageable part of homeownership. Shortages occur due to rising property taxes, insurance premiums, or timing differences during annual escrow analyses. By reviewing your statement, picking the right repayment option, and keeping an eye on your tax and insurance costs, you can stay confident and in full control of your mortgage payments.

Ready to buy a house? Start an application with Rocket Mortgage today.