Homeowners face shortfalls in their escrow accounts as costs rise

In September, Florida homeowner Caroline Hernandez received notice from her mortgage lender that her escrow account which held funds to pay her home 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 up front. She did this with her savings, but six months later her escrow was again short by $1,792, which she again paid with her savings.

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

The scenario is not uncommon now for homeowners. In a previously unpublished 2023 survey from JD Power provided exclusively to Yahoo Finance, 56% of owners indicated that their escrow payment had increased in the past 12 months, up from 51% in 2021 and 49% in 2020.

The shortages reflect increases in home insurance premiums due to natural disasters and inflation and rising property tax assessments after house prices spiked during the pandemic housing market. Shortfalls, however, are causing financial hardship for some homeowners who have already seen their budgets stretched by inflation over the past year.

“Escrow changes are impacted by taxes and insurance, so significant increases that weren’t anticipated will certainly lead to shortages,” said Craig Martin, executive managing director and global head of wealth and benefits management. loans at JD Power, at Yahoo Finance.

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

Credit: Getty Images

Credit: Getty Images

What is Escrow?

After a buyer purchases a home with a mortgage, the lender typically sets up an escrow account to pay 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 occurs once a year.

“The pledge must have enough money to cover home insurance and property taxes for at least two months, so there may be a shortfall if home insurance premiums go up or there may be an increase to put in in place for years to come,” Jason Sharon, a broker-owner of Home Loans Inc., told Yahoo Finance.

Lenders typically base escrow amounts on what was paid the previous year for taxes and insurance, but these amounts can shift, prompting the lender to increase the monthly payment or require a lump sum for reach their minimum escrow balance.

The insurance component

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

On the inflation side, building material and labor costs have been steadily rising and have been exacerbated during the pandemic due to supply chain issues and health precautions.

As a result, the average construction cost for a typical single-family home last year was $153 per square foot, according to a policy survey by the National Association of Home Builders. This marked the highest level in this series’ history and was up 43% from $114 in 2019.

This affects the dwelling’s coverage by home insurance or the cost of repairing or rebuilding the house from scratch. This replacement value generally differs from the fair market value of the home, according to insurer Progressive.

“The reality is that inflation has increased the cost of all aspects involved in a home insurance claim [and] it costs more and takes longer to rebuild homes after a covered loss,” Mark Sektnan, vice president of government relations for the American Property Casualty Insurance Association (APCIA), told the Insurance Journal.

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

“The correlation between climate risk and property damage is increasingly clear [and] underscores the urgency of solutions that address the complex intersection of climate change and real estate trends,” Anand Srinivasan, head of R&D product marketing and innovation at CoreLogic, told Yahoo Finance.

Faced with rising costs, insurers pass this increase on to owners in the form of higher premiums.

“This is an ever-changing situation and it is possible that homeowners in the future will see their mortgage payments change due to increased risk insurance premiums, particularly in risk-prone areas. disasters with hurricanes, wildfires and floods,” Scott Sheldon, branch manager at New American Finance, told Yahoo Finance.

In some cases, insurers are exiting certain markets altogether. For example, 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 homeowner market.

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

“Coastal areas have seen big changes in insurance companies keen to keep this risk in their portfolio and several carriers are pulling out of coastal areas along the east coast, such as South Carolina when the UPC halted the cover,” Sharon said.

When there are fewer insurers, the market “moves more towards a geographic monopoly,” Sharon said, with little competition to help limit 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 may see an increase in property taxes due to people from other states coming into their state incurring tax assessments.”

The pandemic housing boom and the ability to work remotely have spurred inward migration to the regions, driving up home prices in those local markets.

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

But for some owners, the increase is already underway.

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

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

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

For example, homeowners in San Antonio, Texas have an average of $3,941 in property taxes, but homeowners in Austin have the fifth highest property tax in the United States, paying a median of $6,397, according to a LendingTree study.

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

Ways Homeowners Can Cut Costs

High inflation is impacting Americans’ budgets, forcing many to make financial sacrifices, with 57% dipping into their savings to manage the rising cost of living, according to a survey by Nationwide.

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

Some states and municipalities have property tax relief programs if you have a disability, limited income, are a veteran, or are elderly. This is called property tax exemptions.

Although landlords can appeal a property tax assessment, hiring a lawyer can be expensive.

When it comes to lowering home insurance premiums, homebuyers need to 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 is the nearest fire area and does proximity to your home affect hazard insurance premiums?

  • Is your home in a flood zone and how far is the nearest flood zone? If it’s close, have a land surveyor make sure the house is outside of a floodplain.

If you are already at home or shopping for a new insurer, there are options.

Home coverage is based on the cost of rebuilding your home, not the land. So don’t include land value in replacement construction costs to lower your premium, according to the Insurance Information Institute.

Other options for lowering your home insurance premium include increasing your deductible, using a replacement cost estimator, and reducing the amount of your personal property coverage, since the average homeowner doesn’t have no personal property worth $250,000, Sharon said.

If you increase your deductible and live in a disaster-prone area, this can have consequences.

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

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

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