Main image courtesy of The Balance.

If you’re a first time homeowner, it may seem like there are all kinds of new processes that you need to get used to. After all, you’ve just made one of the largest purchases of your life, and you’ve signed up to diligently pay your mortgage each month. While owning a home can be challenging at times, it’s always good to remember that with it, you’re making an investment in yourself and your family—and are starting to build wealth and security. With a home you’ll have more peace of mind knowing what you’ll be chipping away at your mortgage each month, and won’t have to worry about your rent being raised arbitrarily. 

But are your monthly mortgage payments always going to stay the same? And what happens when you receive notice that you have an escrow shortage? Glad that you asked, because in this article we’re going to tackle:

• What your escrow account is
• How you get an escrow shortage
• Your options for dealing with an escrow shortage

What is an escrow account?

Escrow accounts are common in real estate transactions

Once you find your dream home, and put an offer out there, the seller can either accept it or reject it. If they accept it, your real estate agent will direct you to put down earnest money in order to show your commitment to buying the house. Earnest money is a part of your down payment, and is only around 1-2% of the purchase price. This money is not given directly to the seller, but rather is deposited in an escrow account that’s managed by a third party. This keeps the money and both parties protected until you close on the house.

Escrow accounts in real estate will also hold closing costs and the rest of your down payment until closing, dispersing these amounts as detailed in your mortgage agreement. 

Additionally, you’ll continue to use an escrow account after you complete your real estate transaction. This type of escrow account is known as a mortgage escrow account and it will be where your mortgage payments will go each month. Your monthly mortgage payment to this account includes your principal, interest, taxes, and insurance. The escrow account will then pay your taxes and homeowner’s insurance from this account so you do not need to worry about making an additional payment. It’s a nice convenience for homeowners because it makes budgeting each month easier, however, sometimes your escrow account comes up short. 

How do you get an escrow shortage (and is it bad)?

Why is your escrow account coming up short?

Your lender or mortgage servicer will take a look at your account yearly, in order to ensure that the amount you’re paying each month is still enough to cover everything (principal, interest, insurance, and taxes). The amount you owe each month to your mortgage may increase because both insurance rates and taxes can change if your property is reassessed, or your insurance rates go up. If this is the case, it ultimately means that you will have an escrow shortage. Because escrow accounts typically have two months worth of payments, you won’t be in the negative, but your current monthly payment will need to be increased.

You’ll need to accommodate this rise in either your taxes or insurance by paying more each month. It may seem frustrating, but as a homeowner, changes to taxes and insurance are out of your control. You can always shop around for a less expensive homeowner’s insurance policy, but you can’t change local property taxes. 

Options for an escrow shortage

So what do you do if you have a shortage? You have two options if your lender has determined your escrow account is short.

• Lump sum payment. When you receive your shortage notice, your lender will let you know how much your escrow account is short. If it works for you, you can pay this amount in one lump sum to make up the difference.
• Monthly payment. Additionally, you can choose to divide up that number and have it added to your monthly mortgage payment. So instead of paying the $200 shortage as one lump sum, you’ll pay an extra $16.67 dollars for the next 12 months. If you’re worried that you won’t be able to pay your escrow shortage in full, the monthly payment plan is probably the better option. 

Even if you choose to go the lump sum route, you should note that your mortgage payment will still increase in order to account for the change in taxes or insurance. It’s also important to know that an escrow shortage is not a bad thing, and you can experience one at any time during the length of your loan, even after your first year as a homeowner! After all, taxes and insurance costs are constantly fluctuating. 

Can you get an escrow overage?

Just as you can have an escrow shortage, you can also have an escrow overage. This occurs when your lender overestimated the amount they would need to cover your insurance and your taxes, and took out too much monthly. If this happens, your lender will notify you and send you the refund. 

What is an escrow deficiency? 

If your escrow is deficient, this means that you have a negative balance in your account, and is distinct from an escrow shortage. This occurs when there were insufficient funds sent over to the escrow account, leaving your lender with not enough to cover your insurance and taxes. You’ll need to first pay the amount owed to get out of deficiency, and then you can either pay your escrow shortage in full or over a 12 month period.

An escrow shortage is normal and is the result of changes in taxes or your insurance. Your lender or mortgage servicer will inform you whether or not you have a shortage and you can choose how to pay it.