Escrow shortages causing increased mortgage payments

In September, Caroline Hernandez, a Florida homeowner, got a notice from her mortgage lender that her escrow account that held funds to pay her homeowners insurance and property taxes was short by $3,522 because her insurance premiums had increased.

The shortage meant that Hernandez’s mortgage payment would increase by $800 a month unless she paid the entire shortfall upfront. She did with her savings, but six months later, her escrow was short again by $1,792, which she again paid from savings.

“Florida is talking about another 40- to 60-percent increase in homeowners insurance,” Hernandez said. “I can’t afford another shortage.”

The scenario is not uncommon now for homeowners. In a yet unreleased 2023 survey from J.D. Power provided exclusively to Yahoo Finance, 56% of homeowners indicated that their escrow payment increased in the last 12 months, up from 51% in 2021 and 49% in 2020.

The shortages reflect the increases in homeowners insurance premiums from natural disasters and inflation and higher property tax assessments after home prices shot up during the hot pandemic housing market. The shortfalls, though, are causing financial strain for some homeowners who have already had their budgets stretched from inflation in the last year.

“Escrow changes are impacted by taxes and insurance, so material increases that weren’t anticipated will definitely lead to shortages,” Craig Martin, executive managing director and global head of wealth and lending intelligence at J.D. Power, told Yahoo Finance.

“An increase in insurance and taxes could have an impact on some borrowers making their loan unaffordable, but this type of situation is likely to be more of an extreme outcome than a typical one,” Martin said about Hernandez. “That isn’t to downplay the negative impacts on individuals, but from a broader market perspective, it’s not a crisis.”

What is escrow?

After a homebuyer purchases a home with a mortgage, the lender typically establishes an escrow account to pay for property taxes and insurance. A portion of the monthly mortgage payment is held in this account until tax and insurance payments are due, which typically come around once a year.

“Escrow has to have enough to cover homeowners insurance and property taxes for at least two months, so there can be a deficit if homeowners insurance premiums increase or there can be an increase to set up for upcoming years,” Jason Sharon, a broker-owner at Home Loans Inc., told Yahoo Finance.

Lenders typically base the escrow amounts on what was paid the year before for taxes and insurance, but those amounts could be off, prompting the lender to raise the monthly payment or require a lump sum to meet its minimum escrow balance.

The insurance component

In 2022, homeowners insurance premiums increased by 10.72% in the first quarter, according to an S&P Global Market Intelligence analysis. There are two big reasons for this increase: inflation and the increasing prevalence of natural disasters stemming from climate change.

On the inflation side, costs for construction materials and labor have been consistently increasing and were exacerbated during the pandemic due to supply chain issues and health precautions.

That affects the dwelling coverage of homeowners insurance, or the cost to repair or rebuild the home from scratch. That replacement cost value usually differs from the home’s fair market value, according to insurer Progressive.

“The reality is inflation has increased the cost of every aspect involved in an homeowners insurance claim [and] it is costing more and taking longer to rebuild homes after a covered loss,” Mark Sektnan, vice president for state government relations of the American Property Casualty Insurance Association(APCIA), told the Insurance Journal.

And those losses are happening a lot more in many areas where natural disasters are occurring more frequently and at greater intensity due to climate change. A CoreLogic study estimates that annual losses nationwide could increase to $23.5 billion per year by 2050 from now.

“The correlation between climate risk and property damage is increasingly evident [and] underscores the urgency for solutions that address the complex intersection of climate change and real estate trends,” Anand Srinivasan, an executive for research and development product marketing and innovation at CoreLogic, told Yahoo Finance.

Faced with increased costs, insurers are passing this onto homeowners in the form of higher premiums.

“This is an ever-evolving situation and it is possible that homeowners going forward could see mortgage payments change as a result of increased hazard insurance premiums, especially in disaster prone areas with hurricanes, wildfires, and flooding,” Scott Sheldon, branch manager at New American Funding, told Yahoo Finance.

In some cases, insurers are leaving certain markets altogether. For instance, State Farm recently announced that it would no longer issue new policies in California due to wildfire risk and last year AIG announced its intention to exit the California homeowners market.

Florida homeowners are also feeling the financial crunch of premium increases along with trying to find coverage as insurers leave the market. Recently, Florida’s state-run insurer of last resort, Citizens, announced that it was dropping customers.

“Coastal areas have had large shifts in insurance companies willing to maintain that risk in their portfolio and several carriers are pulling out of coastal areas up and down the east coast, like South Carolina when UPC discontinued coverage,” Sharon said.

When fewer insurers exist, the market “moves more towards a geographical monopoly,” Sharon said, with little competition to help keep a lid on premium increases.

The property tax component

“Property taxes are another factor and it’s already happening in some areas — like Idaho,” Sheldon said. “States that don’t have property taxes locked in can see an increase in property taxes as a result of people coming to their state from other states driving tax assessments.”

The pandemic housing boom and the ability to work remotely spurred domestic migration to areas, increasing home prices in those local markets.

“Property taxes are connected to property values, so some homeowners won’t feel it right now because states evaluate property taxes at different times,” Janelle Fritts, former policy analyst at the Tax Foundation, told Yahoo Finance.

But for some homeowners, the increase is already happening.

Last year, $339.8 billion in property taxes were levied on single-family homes in 2022, an increase of 3.6% from $328 billion in 2021, according to ATTOM, which curates land, property, and real estate data. That was more than double the 1.6% increase in 2021.

That translates to $3,901 on the average single-family home, a 3% increase after rising 1.8% the previous year.

Even if your state has low property taxes, your location within that state may have higher property taxes. State tax collections make up 31.1% of property taxes, while local tax collections contribute 71.7%, according to the Tax Foundation.

For example, homeowners in San Antonio, Texas average $3,941 in property taxes, but homeowners in Austin have the fifth-largest property tax in the U.S. paying a median of $6,397, according to a study by LendingTree.

“Because it’s also a local tax, property taxes will be different within states,” Fritts said.

Ways homeowners can reduce costs

High inflation is impacting Americans’ budgets causing many to make financial sacrifices, with 57% dipping into savings to manage rising living costs, according to a Nationwide survey.

“Most states have property tax limitations through a rate limit or levy limit [and] these caps help protect from rising inflation,” Fritts said.

Some states and municipalities have property tax relief programs if you have a disability, limited income, are a veteran or a senior citizen. These are known as property tax exemptions.

Although homeowners can appeal a property tax assessment, hiring a lawyer can be costly.

When it comes to lowering homeowners insurance premiums, homebuyers should be proactive before purchasing their home, especially if they are in a disaster prone area.

“Homebuyers should make sure to get all disclosures from the seller of the home,” Sheldon said. He recommends asking the following questions:

  • Is your home located in a fire zone, and to what extent?

  • How far away is the closest fire zone and does your home’s proximity to it affect hazard insurance premiums?

  • Is your home in a flood area and how close is the nearest flood zone? If it is close, have a land surveyor ensure that the house is outside of a floodplain.

If you’re already in your home or shopping for a new insurer, there are options.

Dwelling coverage is based on the cost to rebuild your home, not the land so don’t include the value of the land in replacement building costs to lower your premium, according to the Insurance Information Institute.

Other options to lower your homeowners insurance premium include raising your deductible, using a replacement cost estimator, and reducing the amount of your personal property coverage because the average homeowner doesn’t have personal property valued at $250,000, Sharon said.

If you raise your deductible and live in a disaster prone zone, that may have consequences.

“If a hurricane hits, I may have to sell my home because my deductible would require me to pay $30,000 out-of-pocket before insurance covers it,” Hernandez said.

Ronda Lee is a personal finance senior reporter for Yahoo Finance and attorney with experience in law, insurance, education, and government.

Ronda Lee
Founder, Editor-in-Chief
Ronda is an attorney, writer, and entrepreneur. She is a contributing writer for the Huffington Post. Originally from Chicago, she has lived in Los Angeles and New York. She loves to travel and is passionate about education equity, especially for first generation college students.