Every year, millions of homeowners receive an annual escrow analysis statement in the mail. If you've opened one only to discover you have an escrow shortage and your monthly payment is going up, you are not alone. In this guide on escrow analysis explained, we will break down exactly how to read your escrow statement, how shortages are calculated, and what your options are.
What Is an Escrow Analysis?
When you have an escrow account, your mortgage servicer collects a portion of your monthly payment to cover property taxes and homeowners insurance. Because tax rates and insurance premiums change from year to year, your lender must review the account annually to ensure they are collecting enough money to pay those bills when they come due. This yearly review is known as an escrow analysis.
An escrow analysis is simply an annual audit of your escrow account to make sure the projected deposits match the expected property tax and insurance disbursements for the upcoming year.
The Minimum Required Balance (The Two-Month Cushion)
When figuring out how to read an escrow statement, the concept that confuses most homeowners is the "minimum required balance," also known as an escrow cushion.
Under federal law (specifically the Real Estate Settlement Procedures Act, or RESPA), lenders are allowed to maintain a cushion in your escrow account to protect against unexpected tax or insurance increases. This cushion is usually equal to two months of escrow payments (or 1/6th of your total annual disbursements).
Example of the Two-Month Cushion
If your annual property taxes are $3,600 and your yearly homeowners insurance is $1,200, your total annual escrow disbursement is $4,800. This means you pay $400 into escrow each month. Your lender will typically require a minimum balance (cushion) of $800 (two months at $400) at the account's lowest point in the year.
How is an Escrow Shortage Calculated?
Your escrow analysis statement will show a month-by-month projection of your account balance for the next 12 months. This projection assumes your current monthly payment stays the same and incorporates the anticipated tax and insurance bills.
If the projected lowest point of your balance falls below the required two-month cushion, the difference is your escrow shortage.
Common Reasons for an Escrow Shortage:
- Property Tax Increases: Your local municipality reassessed your home's value or raised tax rates.
- Insurance Premium Hikes: Your homeowners insurance went up (very common in recent years).
- New Construction Estimates: If you bought a newly built home, the initial taxes were likely based on the unimproved land value. Once assessed as a completed home, the taxes jump significantly.
Worried About Rising Escrow Costs?
Use our Escrow Impact Estimator to see how changes in property taxes and insurance premiums will affect your total monthly mortgage payment over time.
Try the Escrow Impact Estimator →How to Pay an Escrow Shortage
If your annual analysis reveals a shortage, your lender is legally required to offer you options for paying it off, assuming the shortage is greater than one month's escrow payment.
Option 1: Pay the Shortage as a Lump Sum
You can write a check or make a one-time payment to your mortgage servicer for the total shortage amount. This immediately brings your escrow account up to the required minimum balance.
Note: Even if you pay the lump sum, your monthly mortgage payment will likely still increase. The lump sum only covers the deficit from the previous year; your new monthly payment will be adjusted upward to cover the newly increased tax or insurance costs for the coming year.
Option 2: Spread the Shortage Over 12 Months
If you don't pay the lump sum, your servicer will automatically spread the shortage over the next 12 months. They will divide the total shortage by 12 and add that amount to your new monthly payment.
Spreading a Shortage (Example)
If your shortage is $600 and your taxes increased by $300 a year ($25/month), your new monthly payment will increase by $75 ($50 for the shortage catch-up + $25 for the higher tax bill).
Conclusion
Opening an escrow analysis statement with a shortage can be frustrating, but understanding how to read it gives you back a sense of control. By knowing how the two-month cushion works and how shortages are calculated, you can better prepare for fluctuations in your housing costs and decide whether to pay a lump sum or spread the shortage over 12 months.