Escrow Is Probably Why Your Housing Payment Increased

On Jul 3, 2023

The last few years saw a rash of home-buying due to low interest rates and the pandemic. That’s great. But what I’m seeing and hearing more and more now from new homeowners who’ve been in their houses for a year or two is this: “I thought my mortgage payment was fixed, but I just got notice that I have to pay $X00 more per month! What gives, because I can’t afford that. Is my bank scamming me? Is there a mistake? How do I get my payment back to what was promised?”

I understand that this is an alarming turn of events. You bought a house and assumed that your payment would be $X. If your payment is already at the maximum of your affordability, even a little increase can spell trouble. However, it’s not a scam and it’s (probably) not a mistake. Let’s unpack the problem.

First, I’m assuming that you bought a house using a fixed rate mortgage. If you did, then that rate is fixed and will not change unless you somehow initiate a change (i.e., refinance). If you bought a house using an adjustable rate mortgage or some other product, then your problem may very well be that your rate has reset, increasing your payment. But if you used a fixed rate product, your mortgage payment will remain the same.

What’s increasing and causing your pain is your escrow account. This likely includes your property taxes and insurance. Many people bundle these with their mortgage. Your bank may even require escrow in order to make sure their collateral is insured and not in danger of foreclosure due to unpaid taxes. Every month, the portion of your housing payment designated for these items is placed into an escrow account.

When the tax bill or insurance comes due, your bank pays these on your behalf using the money in the escrow account. If there’s a shortfall in the account, the bills will be paid regardless, but then you have to pay the difference back to the bank the next year. This is what many people don’t understand (and lenders and realtors aren’t great at explaining). Your actual mortgage remains the same, but the items in escrow can go up and down. (Generally up, like everything else.)

But why isn’t the escrow account stable? Why does it rise and fall?

When you took out your mortgage, the bank calculated the likely costs of the escrowed items and set your monthly escrow amount accordingly. It’s often an imperfect calculation. They probably used prior tax records and comparable insurance rates from other homes in the area to arrive at their figures for your first year of ownership.

The next year (and every year after), the bank assesses the amount you’re paying into your escrow account and compares it against how much they paid out on your behalf. If you owe money back to the bank because your escrow account came up short, most banks (but not all) will give you a choice: You can pay the amount that was short in one lump sum and deal with a smaller monthly increase going forward to (hopefully) keep you from being short again next year. Or, you can take a higher monthly payment that includes the money needed to cover the short, plus the money needed to cover the coming year’s payments. In either case, your total monthly payment will increase, it’s just a question of how much.

Every year is a guessing game with the bank trying to predict whether or not your escrowed items will increase, decrease, or remain stable. They look at what you paid the prior year, trends in insurance and taxation in your area, and estimate the coming year. Sometimes they over-estimate and your escrowed items either remain stable or decrease. This means that you get a refund at the end of the year for the amount you overpaid into escrow. You may also have a lower payment the next year. This is rare. (In thirty years of home ownership, it has happened to me once.) Most of the time your bank is playing catch up on the ever-increasing escrowed items and so you always owe something the following year.

This process blindsides many people who were simply told, “Your monthly payment will be $X on a thirty year mortgage.” Even people who understand the escrow process can be caught off guard by the speed at which their payment increases. You may only be in your home a year before your payment increases dramatically.

This is because municipalities and insurers all handle their rate increases differently. Some municipalities reassess taxes every few years. If you happen to buy your home the year of a reassessment, you may end up with a higher rate the very next year. Some places reassess when the property changes hands. This means that the tax record your bank used to estimate your taxes won’t actually apply to you. When the reassessment happens, you’ll likely be paying more than the prior owners. And if you bought new construction, the bank may have used the tax value of the empty lot as their basis for your escrow, meaning the next year when the municipality assesses the lot with your house on it, the taxes will go up dramatically.

Insurance is a different beast. Increases are not even always your fault. Your rate may go up due to disasters in the area, or increasing crime. Even if you don’t personally have problems, the insurer is making risk assessments based on your entire area. Most policies also automatically adjust for inflation so that the increased cost to rebuild and replace your stuff is covered. In an inflationary environment like we’re in now, you can expect more frequent increases. Of course, if you file a claim for any reason, expect a higher rate. Your insurer may also do a drive by of your home and note poor roof condition or overhanging/dead trees. They may also look for possible liabilities like broken sidewalks, trampolines, or pools. If they don’t like what they see, you get a price increase.

Taxes and insurance are the reasons you should never take on a monthly payment that is a stretch for you to afford, or one where you’re betting on increased income covering you in the years to come. If your taxes and insurance increase beyond what you can cover, you’ll be in trouble. Always take on less than your max so that you have wiggle room.

And if you think, “Well, I’ll just unbundle my mortgage from the escrow account so my bank can’t keep increasing my payments,” it won’t work (if your bank will even allow it). Sure, your mortgage payment will now always be the same, but you still have to pay for taxes and insurance. You’re still going to have to cover those increases no matter who is paying the bill. Many people only see the price of the house and forget that there are many other costs associated with home ownership. And those costs aren’t always stable or predictable.

If you feel like your taxes or insurance are unfairly priced, your bank cannot help you reduce your payment. Your only options are to shop your insurance to see if you can get a better rate, or appeal your tax assessment to your county or city and hope that they lower your taxes. The first one is easy to do, but the second is a time consuming pain with little hope of success unless some massive error was made (unlikely). So make sure you can afford your payment plus a bit more when you buy your home. It will save you some heartache in the years to come.

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