If you’ve been researching mortgages, or are in the process of taking out a home loan, you’ve probably come across the term “impounds” or “escrows.”
What Are Impounds?
As the name implies, it is an account managed by a third-party, typically a loan servicer, to collect and disperse funds on behalf of the homeowner and lender.
In short, homeowners pay money into the escrow account at closing (and each month after that with their mortgage payment), and when property taxes and insurance are due, the money is sent on to the tax collector or insurance company.
So instead of paying property taxes twice a year, or homeowners insurance once annually, you pay a considerably smaller installment amount each month instead.
This is where the acronym “PITI” comes from – Principal, Interest, Taxes, and Insurance.
You must also pay an “initial escrow deposit” at closing, which will vary greatly based on the month you close, and where the property is located.
And lenders may collect one or two extra months of payments to act as a cushion for future increases in taxes and insurance, but this amount is strictly regulated.
An impound account greatly benefits the lender because they know your property taxes will be paid on time, and that your homeowners insurance won’t lapse.
After all, if you have to pay it all in one lump sum, there’s a chance you won’t have the necessary cash on hand.
Clearly this is important because the lender, NOT you, is the one that truly owns your home when you’ve got a giant mortgage tied to it.
And they don’t want anything to come in between the interest in THEIR property in the event you’re unable to make these critical payments.
Many seem to think lenders require impounds so they can earn interest on your money, but it’s really to protect their interest in the property.
*Some states require lenders to pay homeowners interest on their impound account balances.
In California for example, it is customary for mortgage escrow accounts to earn interest. Be sure to check your own state law to determine if you’ll earn interest. In any case, it likely won’t be very much money, and it’s taxable…
Impound accounts can also benefit borrowers because the money is collected gradually over time, so there isn’t that big unexpected hit when taxes or insurance are due.
For this reason, some borrowers actually prefer impound accounts, especially those that tend to do a poor job managing their own finances.
Paying Taxes and Insurance Yourself
However, if you’re the type that likes full control over your money, you can always pay your property taxes and homeowners insurance yourself.
In this case, you “waive impounds,” which usually entails paying a fee, such as .125% or .25% of the loan amount at closing.
For example, if your loan amount is $200,000, you might be looking at a cost of $250 to $500.
Of course, waiving impounds/escrows may also come in the form of a slightly higher mortgage rate if you don’t want to pay the escrow waiver fee out-of-pocket.
Either way, there is typically a cost, though you can always try to negotiate with the lender to get them waived and still secure a low rate.
Just keep in mind that you can’t always waive impounds.
For conventional loans, impounds are generally required if you put less than 20% down.
And even then, many lenders now charge borrowers if they want to waive impounds, even if their loan-to-value ratio is super low.
In California, impounds are only required if the loan-to-value ratio (LTV) is 90% or higher. But you may still have to pay to waive them either way.
It’s seemingly unfair, but like all other businesses, they got creative and came up with yet another thing to charge you for. Sadly, you should be used to it by now.
If you initially set up an escrow account, you may be able to get it removed later down the line.
Simply contact your loan servicer and ask them to review your account. As a rule of thumb, it’s more likely to get approved if your LTV is below 80%.
That 20% in home equity gives the lender sufficient protection from potential default.
Additionally, each year on the anniversary date of your loan closing, your lender is required by federal law to audit your impound account and refund any excess over the allowable cushion.
So if it appears as if your impound account is a little too full, ask them to take a look via an escrow account overage analysis.
You can elect to apply any overage to principal reduction, apply it to a future mortgage payment, or have it refunded in cash.
It’s also possible that you may experience an escrow shortage, in which case you’ll be billed for the amount needed to satisfy the shortfall.
It’s Always Your Responsibility
Regardless of whether you go with impounds or decide to waive them, it is your responsibility to ensure that your property taxes and insurance are paid on time.
Sure, your loan servicer will probably pay on time, but this may not always be the case.
If you’re subject to paying supplemental property taxes, your loan servicer may tell you that it’s your responsibility to take care of them.
In other words, you’ve got to pay the taxes yourself – they won’t come out of the escrow account.
So always keep an eye on your escrow account, and keep good records of your taxes and insurance!
(photo: Constantine Agustin)