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If you’re a first time home buyer, the mortgage and home purchasing process may seem a little overwhelming at times. There’s lots of terminology thrown around that you’re probably not accustomed to as well as a variety of forms to fill out and procedures to follow. One of the terms you’ll likely come across after you decide on a lender is an escrow account. 

This is a common occurrence in the home mortgage industry, but you may find yourself wondering what it is and what it has to do with the purchase of a home. If you’d like to learn a little more about escrow accounts, and what to do if you have a shortage, keep reading because we’re going to cover:

• What an escrow account is 
• What to do if you have an escrow account shortage
• The difference between an escrow shortage and an escrow deficiency

What is an escrow account?

Homeowners use escrow accounts to make paying their mortgage simple

An escrow account is set up when money needs to be held safely until particular conditions are met, and they are used frequently in real estate. If you’re going through the home buying process, you’ve probably heard of earnest money, or good faith deposit. This is a certain amount that you as the buyer are willing to put down in order to show your interest in a home. In order to hold that amount securely until the rest of the home buying process can be completed, an escrow account is created by a mortgage servicer or your lender.

Once everything falls into place and you close on your home, the money you placed in the escrow account will then be applied to the down payment of your home. 

In addition to frequently being used to hold earnest money, escrow accounts are also used by your lender to collect and disperse taxes and insurance fees. Typically the mortgage for a home can be separated into two parts that make up the total amount you pay each month: the amount that goes towards principal and interest, and the amount that goes towards property taxes and homeowners insurance. The amount that goes towards taxes and insurance is held in an escrow account and is only distributed when those items are due. 

Having to worry about just one monthly mortgage payment makes it easy for homeowners to keep up with their payments, since their lenders (or another mortgage servicer or escrow company) ensure that taxes and insurance are paid for them. Instead of having to remember to pay multiple companies, the one payment does it all. Since an amount to cover taxes and insurance is taken out each month, you don’t have to worry about making a large lump sum payment at the end of the year, as you’re paying a little bit each month.

What is an escrow shortage?

What happens if you have an escrow shortage?

Having a monthly mortgage payment that includes your principal, interest, taxes, and insurance is great for homeowners because they know exactly what they’re expected to pay each month. It makes it easier to create a budget and plan accordingly. Your mortgage servicer will make sure that payments for taxes and insurance are distributed, and typically require the homeowner to have at least two months of payments in their escrow account as a cushion in case of an increase. Taxes and insurance on your property can change from time to time, and what it changes to and how often it changes are largely out of your control. 

When either your taxes or insurance are adjusted, there’s the possibility that you’ll end up with an escrow shortage for that year. When they set the amount to be taken out each year, mortgage servicers do an analysis to estimate your taxes and insurance costs. But since increases in either of those two parts of your mortgage payments can be unforeseen, they will let you know if there is a cost to be made up. 

What are my options if I have an escrow shortage?

When you have an escrow shortage, it means there aren’t enough funds in your escrow account to cover your payments going forward, and you’ll need to find a way to make up for the difference. Typically homeowners have two choices:

• Pay the lump sum
• Factor it into 12 monthly payments over the next year

Doing either of these two actions will take care of your escrow shortage, but it’s important to note that your mortgage payment will likely still increase to cover the cost of the increase in either your taxes or insurance. Choose the option that fits your budget best, because as long as you’re making the payments required by your lender, you should be just fine.

Is an escrow deficiency something different?

When you have an escrow shortage, there is still a positive balance in your escrow account, but not enough to cover the increase in either your property taxes or insurance premiums. An escrow deficiency, while it may sound similar, is something else. This occurs when you have a negative amount in your escrow account because you’ve missed payments. Since there is a two payment cushion in your escrow account, your mortgage servicer would have had to dip into that in order to make the necessary disbursements. You’ll need to pay back that amount plus make up for additional escrow shortages.

Having an escrow shortage happens to every homeowner, because property taxes and insurance rates are constantly changing. Your mortgage servicer tries to estimate the right amount that will need to be taken out of your payment and put into escrow, but sometimes they may underestimate that amount. Just make sure you pay the lump sum or split it into 12 monthly payments.

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