Navigating the world of real estate can be complex, especially when it comes to financial aspects like escrow accounts. Some of us think that our monthly mortgage is a fixed cost and that we will pay the same amount until it matures. Not true, according to the Consumer Financial Protected Bureau, six reasons can cause a change in your mortgage payment, adjustable rate mortgage, interest only, your escrow account to pay your property taxes or homeowners insurance increase, a decrease in your interest rate or your escrow payments, you were charged new fees, or there was a mistake.
In this article, we are going to focus on your escrow account to pay your property taxes or homeowners increase. What is an Escrow Account? In real estate, these accounts are used to securely hold money that will be used for property taxes and homeowners insurance. Each monthly mortgage payment has a portion for property tax and home insurance. The escrow ensures that the payments are made timely and reduces the risk of defaulting on your home.Â
Why Do Escrow Shortages Occur? Escrow shortages can happen if your local government raises property taxes, then the amount required in escrow will increase, potentially creating a shortage. If there is a rise in your home insurance premium this will require additional funds in your escrow account. Sometimes, lenders might underestimate the amount needed for taxes and insurance, leading to a shortfall.
How to Avoid Shortages in Your Escrow Account? Keep track of your property tax changes on your state’s website. The tax bill will have your tax amount and you can review the assessment roll for anticipated changes. For example, in New York, the tentative assessment roll is made public on May 1st for each county.Â
Sample Overview of the assessment roll example below.
Source: tax.ny.gov Legend: A: SWIS (State Wide Information System), B: Uniform percentage of market value, C: Valuation date, D: Taxable status date, E: Tax map parcel number, F: Property location and class, G: Land assessment, H: Total assessment, I: Full market value, J: Exemption, K: Tax description, L: Assessor's oath
Reviewing the information is your responsibility, and if you think there is an error contact your assessor by the deadline. If you anticipate an increase after reviewing the above you can prepare accordingly. Another document you should review annually is your home insurance policy to ensure you're getting the best deal and adjust your escrow contributions if your premium changes.Â
Lenders usually provide annual escrow statements; by the time you receive this annual escrow statement, your mortgage payment will either have increased or you have overpaid. Usually, the mortgage lender will send you a check. Some homeowners will return the check to the escrow account to avoid a shortage. Keep in mind that after reviewing your tax bill, overview of the assessment roll, and home insurance policy you can make additional contributions if you anticipate a shortage to your escrow account to cover the expected increase in taxes or insurance.
Example of Escrow Account Without Shortage.Â
Annual Property Taxes: $2,400. Annual Home Insurance: $1,200
 How It Works:
- Each month, $300 is added to the escrow account ($200 for taxes, $100 for insurance).
- By the end of the year, the escrow account holds $3,600.
- The lender uses $2,400 for property taxes and $1,200 for home insurance, exactly matching the annual requirements.
- Result: The escrow account is perfectly balanced with no shortage.
Take the same mortgage statement above. Mortgage Payment: $1,500 monthly
Breakdown:
- Principal and Interest: $1,200
- Escrow (Taxes and Insurance): $300Â
- Annual Property Taxes: Initially $2,400, but unexpectedly increased to $2,700 mid-year.Â
- Annual Home Insurance: Remains at $1,200
How It Works:
- Each month, $300 goes into the escrow account, as before.
- However, due to the tax increase, the account is now short.
- By year-end, the account has $3,600, but the actual expenses are $3,900 ($2,700 for taxes, $1,200 for insurance).
- Result: There is a shortage of $300 in the escrow account.
Note: The shortage in the escrow account will result in an increased monthly payment in the following year to cover this deficit.
If there is a shortage or an overage in your escrow account, the bank or lender typically takes the following actions:
In Case of an Escrow Shortage:
Notify the Homeowner: The lender will send a statement detailing the shortage amount and the reason for it, usually due to an increase in property taxes or insurance premiums.
Offer Options to Cover the Shortage: Lump-Sum Payment: The homeowner can choose to pay the entire shortage amount in one lump sum. Amortize Over the Next Year: Alternatively, the lender may spread the shortage amount over the next 12 months, adding it to the monthly mortgage payment.
 Adjust Future Payments: Regardless of how the shortage is settled, the monthly escrow payment may increase to prevent future shortages. This adjustment is based on the new estimates for taxes and insurance for the upcoming year.
In Case of an Escrow Overage:
Review the Account: If the escrow account has more funds than needed, the lender will review it to confirm the overage.
Notify the Homeowner: The lender will send a statement with details of the overage.
Refund or Credit: Refund: If the overage exceeds a certain amount, typically determined by state laws or the terms of the mortgage agreement, the lender will refund the excess amount to the homeowner. Credit to Future Payments: In some cases, or if the overage is small, the lender might apply the excess funds as a credit towards future escrow payments, reducing them accordingly.
Adjust Monthly Payments: Similar to a shortage scenario, the lender may adjust the homeowner's future monthly escrow payment to reflect the actual costs for taxes and insurance, aiming to prevent future overages or shortages.
In both cases, homeowners need to review their escrow analysis statements carefully and contact their lender if they have questions or need clarification about their escrow account status.
In conclusion, an escrow account is an essential tool in real estate, helping homeowners manage the critical expenses of property taxes and home insurance. By understanding how these accounts work and staying vigilant about potential changes in tax rates and insurance premiums, homeowners can avoid escrow shortages and ensure smooth financial management of their property. Remember, staying informed and proactive is key to a hassle-free homeownership experience.