Escrow shortage: How to handle it, and ways to avoid it

Did you just open a letter from your lender saying you have an escrow shortage? That uneasy feeling is normal—because it usually means your monthly mortgage payment is about to climb, sometimes by hundreds of dollars.

Your lender uses an escrow account to collect money each month for property taxes and homeowners insurance. If those costs are underestimated or rise unexpectedly, your account doesn’t have enough to cover the bills. That’s one of the most common reasons your mortgage payment may suddenly increase.

The good news is that once you understand what causes escrow shortages—and how to deal with them—you can make smart choices to minimize the impact. This guide breaks down what an escrow shortage is, why it happens, and the practical ways you can respond. We’ll also share strategies for avoiding shortages in the future so you can keep your mortgage payments more predictable.

What is an escrow account?

An escrow account is essentially a savings account managed by your mortgage lender. Each month, a portion of your mortgage payment goes into this account, and the funds are used to pay recurring housing costs like property taxes and homeowners insurance.

Think of it as a budgeting tool that spreads out large expenses over the year. Instead of paying thousands in one lump sum, you chip in smaller amounts monthly. This protects you from big, surprise bills and reassures your lender that these important obligations will be paid on time.

Most lenders require escrow accounts—especially if you have less than 20% equity in your home. The payment amount is calculated based on estimated annual costs, divided into 12 monthly contributions.

Since taxes and insurance premiums can change every year, your escrow account balance and monthly mortgage payment may fluctuate too. That’s why knowing how escrow works can be especially useful when you’re considering refinance rates or running numbers with a refinance calculator.

What is an escrow shortage?

An escrow shortage happens when your account doesn’t have enough money to cover property taxes or insurance when they come due. In other words, the actual costs turned out to be higher than what your lender originally estimated.

When this happens, your lender steps in to pay the bills on your behalf, which creates a negative balance in your escrow account. You’ll then receive a notice explaining the shortage and outlining repayment options.

Lenders typically try to avoid this with an escrow analysis, an annual review to ensure the funds in your escrow account are sufficient to cover your property taxes, homeowners insurance, and other escrowed items, but it does happen.

Escrow shortage vs. escrow deficiency

Although the terms are often used interchangeably, there’s a difference:

• Escrow shortage means you owe more because future estimates weren’t high enough, and you can usually spread repayment over time.
• Escrow deficiency is a more serious shortfall, often from missed payments or significant miscalculations, and usually requires immediate repayment.

Knowing which applies to your situation can help you budget and plan. Lenders typically review escrow accounts once a year with an escrow analysis and adjust monthly payments to prevent future issues.

What causes an escrow shortage?

Several factors can cause an escrow shortage:

• Higher property taxes – Local governments may reassess property values or raise tax rates without much notice.
• Insurance premium increases – Rising construction costs, claims history, or natural disasters in your region can cause premiums to jump.
• Initial underestimates – Especially common with new homes or recent purchases where reliable tax and insurance data wasn’t available.
• Processing errors – Delays or mistakes in payments can temporarily drain your account.
• Home improvements – Renovations that raise your property’s value often lead to higher taxes later.

Even with careful planning, some of these changes are out of your control. That’s why many homeowners keep an eye on refinance rates or use a refinance calculator as part of their long-term financial strategy.

Example of an escrow shortage

Let’s say your lender estimated your annual property taxes at $3,600 and homeowners insurance at $1,200, for a total of $4,800. That works out to $400 a month into escrow.

But at the end of the year, taxes actually came in at $4,200 and insurance at $1,500—a total of $5,700. That’s $900 more than expected.

Your lender only collected $400 a month, but paid out $5,700, leaving a $900 shortage.

To fix it, they’ll:

• Increase your monthly escrow payment to $475 ($5,700 ÷ 12) going forward.
• Ask you to repay the $900 shortage.

If you spread repayment over 12 months, your payment goes up by $150 per month ($75 for the higher ongoing costs, plus $75 toward the shortage).

How to deal with an escrow shortage

When you get a shortage notice, you usually have three repayment choices:

1. Pay the full amount upfront – Wipes out the shortage immediately and keeps monthly payments more predictable.
2. Spread repayment over 12 months – Breaks the shortage into manageable pieces, though your monthly payment will rise.
3. Split the difference – Pay part now and spread the rest over time. This lowers both the lump-sum payment and the monthly increase.

Before deciding, it’s worth checking refinance rates or using a refinance calculator to see if refinancing could help offset rising housing costs.

How to avoid an escrow shortage

Preventing a shortage is easier than fixing one. Here’s how to stay ahead:

• Review property tax assessments regularly and appeal if they seem too high.
• Shop around for insurance each year to avoid overpaying. Bundling policies can cut costs.
• Set aside a cushion in a separate savings account to cover unexpected increases.
• Tell your lender about changes in your tax bill or insurance premiums as soon as you know.
• Plan for yearly increases by budgeting a little extra into your monthly mortgage payment.

Some homeowners also use a refinance calculator to see if lowering their overall mortgage costs frees up more room for escrow fluctuations.

How to reduce escrow payments

If you want to lower your escrow contributions, you have options:

• Challenge your property tax assessment if it looks inaccurate.
• Cut insurance costs by raising deductibles, installing safety features, or bundling with other policies.
• Consider removing escrow if you have at least 20% equity and a strong payment history. (This means you’ll manage your own tax and insurance payments, so discipline is essential.)

Since higher taxes and insurance are usually the reason your mortgage payment went up, targeting those expenses can help keep future escrow payments down. Checking refinance rates can also reveal long-term ways to bring down overall housing costs.

Escrow shortage FAQs

What if I can’t afford my escrow shortage?

Call your lender right away. Many offer hardship plans, forbearance, or extended repayment schedules.

Should I pay the full shortage all at once?

It depends. Paying it off upfront keeps monthly payments lower, but don’t drain your emergency fund to do it.

Will paying in full lower my monthly payment?

Not exactly. Your payment will still rise to cover the higher taxes or insurance going forward, but paying the shortage upfront removes the temporary repayment portion. To truly reduce your monthly payment, check today’s refinance rates or run numbers with a refinance calculator.

Conclusion

An escrow shortage can be stressful, but it doesn’t have to derail your finances. With the right approach—whether paying in full, spreading it out, or a combination—you can handle it without losing stability.

Better yet, you can take steps now to prevent future shortages. Staying on top of tax assessments, reviewing insurance annually, and building a cushion in your budget all help keep your mortgage payments steady.

If you have enough equity, you may even be able to remove escrow altogether, though that means managing tax and insurance payments yourself. Exploring refinance rates and using a refinance calculator can also reveal ways to reduce overall costs.

The key is to act quickly when you get that shortage letter and explore every option available. With proactive planning and a clear strategy, you can keep your homeownership journey steady and financially secure.