If you’re like a majority of homeowners today, you have a mortgage with an escrow account. And like most of those homeowners, you understand the basics of escrow, but when it comes to shortages and overages, it can be difficult to keep it all straight.
As a quick refresher, an escrow account is an account that holds the funds you need to pay your property taxes and homeowners insurance. It’s not an account that you manage directly. It’s simply a holding account that contains the funds you pay every month to ensure your taxes and insurance bills are paid.
By consolidating these payments into your monthly mortgage payment, you only have to worry about one bill rather than several bills all due at different times. We help you by making sure you have enough money in your account to cover your bills; then when they’re due, we pay them on your behalf. It’s a service that is designed to make your life easier.
So where does that money come from?
It comes directly from your monthly mortgage payment. When you’re looking at your payment amount, it’s helpful to view the payment as two categories – one for principal and interest (the amount that goes toward paying off your home loan) and the other for property tax/homeowners insurance/mortgage insurance. How much of the money you pay that goes to your escrow account is determined by your yearly escrow analysis. The difficulty comes when trying to accurately estimate or predict the amount of taxes that will be required of you in the coming year or changes in insurance premiums.
Sometimes it’s overestimated, but often it’s underestimated. That’s where the escrow shortage appears.
For example, if you buy a home that was built for you, your initial tax assessment will more than likely only consider the land value of the home. But once the property is assessed again, it will include the land value PLUS the value of your home. As a result, your property taxes will increase and so will your escrow payment. Which means, ultimately, your monthly mortgage payment will increase.
In other words, an escrow shortage is the result of not having enough money in your escrow account to cover the actual amount needed to pay your bills. It sounds as simple as it is.
Here’s another example:
If your annual tax payment is projected to be $2,400, $200 goes to your escrow account every month. ($2,400 divided by 12 months in a year). If your projected insurance amount is $1,200, $100 goes to escrow every month.
So if you have a $1,200 monthly mortgage payment, $900 goes toward your principal and interest, while the remaining $300 goes toward your escrow account every month.
However, at the time of your escrow analysis, let’s say that your taxes have been assessed and they have increased from the amount we thought they would be during last year’s analysis. The actual amount comes in at $3,000 for taxes and $1,600 for homeowners insurance – that’s a difference of $1,000.
TAXES: $2,400 – escrow analysis prediction
$3,000 – Actual
INSURANCE: $1,200 – escrow analysis prediction
$1,600 – actual
– $400 difference
Total shortage: -$1,000 for the tax/insurance bill.
At this point, you’re responsible for the $1,000 required to make up the total amount due for your taxes and insurance. Additionally, you’ll notice an increase in your monthly mortgage payment. The reason for this increase is to cover the newly assessed taxes and homeowners insurance.
Here are some more things to consider
Is there a difference between an escrow shortage and an escrow deficiency? While these words may seem similar, in the world of escrow, they’re different entities. An escrow shortage occurs when there is a positive balance in the account, but there isn’t enough to pay the estimated tax and insurance for the future.
An escrow deficiency is when there’s a negative balance in your escrow account. This happens when we’ve had to advance funds to cover disbursements on your behalf. So not only are you going to be short for your upcoming tax and insurance payment, but you also owe money to bring your account current.
How often does the escrow account get analyzed? We look for changes in tax and insurance in the form of an escrow analysis once a year. However, if we see an issue that requires further examination, we can do an analysis to determine its impact on your payment.
How can you be proactive in managing your escrow account? Pay attention to any information you get from your city regarding tax information or from your homeowners insurance company. They will often send you information in the mail about trends and increases. This can help you plan ahead. Keep an eye on insurance trends yourself and shop around to make sure you’re getting the best rate you can. Or, set aside a savings account you deposit a set amount into as an escrow back up plan. This way if your escrow account does wind up short, you’ll have the extra funds to pay it immediately rather than roll that into your monthly payment.
Rates have nothing to do with your escrow payment. “But I have a fixed-rate mortgage! My payment is not supposed to increase.” Which is true, and it doesn’t. Remember how I suggested to view your monthly payment as two parts – a principal/interest part and the escrow part? If your rate is fixed, the amount you pay toward your principal and interest doesn’t change. The amount that does affect your monthly payment is the taxes and insurance part.
For example, using the same numbers from our example above:
10-year mortgage: $1,200 monthly mortgage payment of which $900 goes toward principal and interest, and $300 goes to escrow.
The next year, your city’s taxes increase. The new estimate states we now need $500 per month instead of $300 to cover your tax and insurance bills. This increases your monthly mortgage payment to $1,400. $900 of that amount still goes to your premium and interest. It has not changed.
But if I’m only short X amount, why am I required to pay Y? Here’s a real-world scenario: I received my escrow analysis statement and it said I’m short $1,600. The only thing that changed is that my homeowners insurance went up by $800. Why am I paying double?
Here’s what’s happening: The escrow account was short $800 to cover the payment for my insurance. So I’ve got a deficit of $800. The other $800 makes up the difference for the future payment of my homeowners insurance. This will get me caught up and hopefully not in a shortage situation next year. Effectively, I’m paying $800 for last year and then $800 for this year.
If there is a home that you would like more information about, if you are considering selling a property, or if you have questions about the housing market in your neighborhood, please reach out. We’re here to help.