By Mike Miles
When we underwrite a borrower, we calculate the full mortgage payment due as part of the debt-to-income calculation. A full mortgage payment consists of principle, interest, taxes, insurance (PITI) and PMI when applicable. The principle and interest portion represent the payment associated with the note/loan. The taxes and insurance portion represent the part of the payment known as the escrow. This mysterious escrow can have a bad habit of being short, which is irksome.
Let’s dive into some questions and explanations of the how and why escrows can be short.
Who creates the escrow account?
The lender sets up the initial escrow account. The variables used include first payment dates of the new loan and the both the due dates and amounts of the property tax and insurance bills.
How is it determined how much to set up?
Lenders use operating software to create the initial escrow account. The variables above are data entry points and there is a two-month cushion for both taxes and insurance added to the initial setup. So as long as the lender entered the amounts and due dates correctly, the software does the rest.
If the lender sets it up correctly, why could an escrow account be short?
The escrow account setup uses the amounts due for the current insurance and tax bills. The two-month cushion is used to help absorb any increase of those amounts as time passes. If the insurance and tax bills both increase to the point of exhausting that cushion, the lender/servicer will need to adjust your mortgage payment to keep pace with the increased amounts.
If there is a shortage … what happens?
If your payment includes escrows, those tax bills and insurance bills can never go unpaid even if there isn’t enough money in the escrow account to pay them. The lender will front the money and whatever amount the lender paid on your behalf to cover the shortage will need to be repaid by you. This repayment is generally offered to be done in a couple ways. It can be a lump sum payment, or it can be paid over a stretch of months. This repayment is in addition to any calculated escrow increase in order to keep pace with your renewed tax and insurance bills.
What can be done to avoid a shortage?
I always suggest reviewing your home insurance coverage every year. It’s quite normal for insurance premiums to increase annually. If you don’t pay attention to it, your insurance agent/company can get pretty aggressive with your premium increases. I suggest getting a new quote every year your premium renews. Additionally, pay attention to your tax bills. A healthy real estate market is great for home values, but it can also mean higher tax bills. Some tax bills have increased at a tremendous rate which makes it nearly impossible for escrow accounts to keep pace. You have a right to appeal any property tax increase. The appeal process is noted on your tax bill notifications you receive in the mail. You’d be surprised at how many homeowners are successful with an appeal.
Unfortunately, there isn’t much that can be done about an escrow shortage when it happens. However, understanding the how and why can help make it more palatable when it happens.