September 30, 2023

Homeowners face shortfalls in their escrow accounts as costs rise

In September, Caroline Hernandez, a Florida homeowner, received a notice from her mortgage lender that her escrow account, which held funds to pay for her homeowner’s insurance and property taxes, was $3,522 short because her insurance premiums had risen.

The shortfall meant Hernandez’s mortgage payment would increase by $800 a month unless she paid the entire shortfall up front. She made do with her savings, but six months later, her bail was again short of $1,792, which she again paid out of savings.

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

The scenario is now not unusual for homeowners. In an unreleased 2023 survey from JD Power, exclusive to Yahoo Finance, 56% of homeowners said their security deposit payment has increased in the past 12 months, compared to 51% in 2021 and 49% in 2020.

The shortfalls reflect increases in homeowners’ insurance premiums due to natural disasters and inflation and higher property tax bills after home prices skyrocketed during the hot pandemic housing market. However, the shortfalls are causing financial pressure for some homeowners who have already stretched their budgets over the past year due to inflation.

“Changes on bail are impacted by taxes and insurance, so material increases that were not anticipated will certainly lead to shortfalls,” Craig Martin, executive director and global head of wealth and loan information at JD Power, told Yahoo Finance.

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

Credits: Getty Images

Credits: Getty Images

What is bail?

After a home buyer buys a home with a mortgage, the lender typically opens 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 are usually once a year.

“Escrow should have enough to cover homeowners insurance and property taxes for at least two months, so there could be a shortfall if homeowners’ insurance premiums go up or there could be an increase for years to come,” Jason Sharon, a realtor- owner at Home Loans Inc., told Yahoo Finance.

Lenders typically base escrow amounts on what was paid for taxes and insurance the previous year, but those amounts may vary, forcing the lender to increase the monthly payment or charge a lump sum to meet their minimum escrow balance.

The insurance part

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

In terms of inflation, construction materials and labor costs have risen steadily and exacerbated during the pandemic due to supply chain issues and health concerns.

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

That affects homeowners insurance coverage, or the cost of repairing or rebuilding the home from scratch. That replacement value usually deviates from the market value of the home, according to insurer Progressive.

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

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

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

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

“This is an ever-evolving situation and it is possible that homeowners could see mortgage payments change in the future due to higher risk insurance premiums, especially in disaster-prone areas with hurricanes, wildfires and floods,” Scott Sheldon, branch manager at New American Funding, told Yahoo Finance .

In some cases, insurers are abandoning certain markets altogether. For example, State Farm recently announced 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 crisis of premium increases and trying to find coverage as insurers exit the market. Recently, the state-run insurer of last resort, Citizens, announced it would be dropping customers.

“Coastal areas have seen major shifts in insurance companies willing to hold that risk in their portfolios and several carriers are pulling out of coastal areas along the East Coast, such as South Carolina when UPC dropped coverage,” Sharon said.

When there are fewer insurers, the market moves “more toward a geographic monopoly,” Sharon said, with little competition to control premium increases.

The property tax section

“Property tax is another factor and it’s already happening in some areas, like Idaho,” Sheldon said. “States that don’t have property taxes may see a rise in property taxes due to people coming to their state from other states and imposing tax bills.”

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

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

But for some homeowners, the rise is already underway.

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

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

Even if your st
ate 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.

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

“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 US budgets, causing many to make financial sacrifices, with 57% diving into savings to contain the rising cost of living, according to a Nationwide survey.

For homeowners concerned about increased homeowners insurance premiums and property taxes.

“Most states have restrictions on property taxes through a rate cap or levy cap [and] these caps help protect against rising inflation,” Fritts said.

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

While homeowners can appeal a property tax bill, hiring an attorney can be costly.

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

“Homebuyers should make sure they get all the 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 nearest fire zone and does proximity to your home affect life insurance premiums?

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

If you’re already at home or looking for a new insurer, there are options.

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

Other options for lowering your homeowner’s insurance premium include increasing your deductible, using a replacement cost estimator, and lowering the amount of your personal property coverage because the average homeowner does not own $250,000 worth of personal property. Sharon said.

If you increase your deductible and live in a disaster-prone zone, there could be consequences.

“If a hurricane hits, I might have to sell my house because I have to pay $30,000 out of pocket for my deductible before the insurance will 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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