Are you getting ready to buy a home? Maybe you’re thinking of refinancing and you’re shopping around for a lender? Applying for and getting approved for a mortgage is a much simpler process than it used to be. Today, the financing choices are conventional loans and government-backed mortgages and mortgage companies use the same basic set of underwriting guidelines when evaluating a mortgage application. Of course there are exceptions and we do pride ourselves on offering a wider range of mortgage options but generally speaking, most every mortgage company or bank will provide conventional or government-backed choices.
Yet even though the approval process is more streamlined than it used to be you’re still going to make several decisions before and during the application process. Beyond the type of loan, you’ll also need to decide between a fixed and an adjustable rate. Do you want to pay discount points to lower your rate? What about a 25 year fixed instead of a 30-year term? For most people adding a mortgage to their financial picture creates the largest impact compared to any other financial decision. It’s no small thing. But one more decision you’ll need to make is whether or not to create impound accounts to pay your property taxes and insurance. Are they a good idea?
What is An Impound Account?
When borrowers create impound accounts they’re creating a fund that will automatically pay the property tax bills when due as well as renewing the insurance policy. Each month as a borrower makes a mortgage payment to their lender in addition to the principal and interest payment made an additional amount goes toward funding impound accounts. Here in San Diego County and elsewhere across the state, homeowners pay their annual property tax bill in two installments. Homeowner’s insurance premiums also renew annually.
In addition to the principal and interest payment, one-twelfth of each annual bill is paid into the impound account. When the bills arrive, the payments are made automatically by the lender from the impound account funded by the borrower.
So, should you create impound accounts?
The choice really is automatically made for you if your first mortgage lien is greater than 90% of the value of your home. In this case, lenders require you to have impounds. Some lenders require impounds when the first lien is greater than 80% of the current value. That also means the government-backed suite of mortgage programs of VA, FHA and USDA require impound accounts and you don’t have the option.
But if you do have the ability to decide whether or not to impound for taxes and insurance it may be more of a personal choice instead of a financial one.
First, lenders like their borrowers to have impound accounts. That lets the lender sleep a little better knowing you won’t become delinquent on property taxes and the lender’s collateral-your home- is covered in case of any damage or destruction. When borrowers become seriously delinquent on their property taxes they can expect a tax lien to be placed on the property and could ultimately lead to a property tax foreclosure. That’s what keeps lenders awake at night.
If you put down 20% or more and decide not to create impound accounts you might encounter an impound waiver fee. This is a bit of financial incentive to borrowers to create impound accounts. This fee can vary depending upon the lender and loan program selected but typically this fee is .25% of the loan amount. If you have a $400,000 loan and waive impounds, you can expect to pay an additional $1,000 at closing for the privilege. Or, the interest rate on the loan might be slightly higher for loans without impound accounts. Either way, the loan will be slightly more expensive without impounds.
Many borrowers who choose to have impound accounts do so for a couple of reasons. The first is for convenience. Instead of paying property taxes in two large chunks each year, a smaller amount is paid each month, much like an automatic savings account. Second, it’s easier on the cash flow to make smaller payments instead of big ones.
For those who do not select impounds, they might prefer to put that money in some sort of interest-bearing account and pay the bills when due. They might decide to invest those funds somewhere else. In California, lenders are required to pay borrowers interest on impound accounts but the rate is minimal.
| 1st Installment | 2nd Installment | |
| Due Date: | November 1st | March 1st |
| Delinquent Date: | December 19, 5:00pm | April 10, 5:00pm |
| Period Covered: | July- December | January-June |
* Loans closing February 19 and after require the 2nd tax installment be paid prior to or at closing.
**Loans closing October 21 and after requires the 1st tax installment be paid prior to or at closing.
| Month of Funding | First Monthly Payments | Tax Impounds Collected |
|---|---|---|
| January | March | 7 Months Collected (1st Installment Paid, 2nd Installment not paid) |
| February | April* | 7 Months Collected (1st Installment Paid, 2nd Installment not paid) |
| February | April | 2 Months Collected (1st & 2nd Installment Paid) |
| March | May | 3 Months Collected (1st & 2nd Installment Paid) |
| April | June | 4 Months Collected (1st & 2nd Installment Paid) |
| May | July | 5 Months Collected (1st & 2nd Installment Paid) |
| June | August | 6 Months Collected (1st & 2nd Installment Paid) |
| July | September | 7 Months Collected (1st & 2nd Installment Paid) |
| August | October | 8 Months Collected (1st & 2nd Installment Paid) |
| September | November | 9 Months Collected (1st & 2nd Installment Paid) |
| October | December | 10 Months Collected (1st & 2nd Installment Paid) |
| October | December** | 4 Months Collected (1st Installment Paid, 2nd Installment not paid) |
| November | January | 5 Months Collected (1st Installment Paid, 2nd Installment not paid) |
| December | February | 6 Months Collected (1st Installment Paid, 2nd Installment not paid) |
Setting Up the Account
Lenders will require you to set up an impound account and depending upon the lender you may be required to pay up to two months of your annual insurance premium as well as fund your property tax account. Depending upon the time of the year when you close, your property tax impound account might be anywhere from two to five months of taxes.
These “overages” are created in order to cover any increase in property taxes and insurance. If property taxes go up one year to the next and the lender created the impound account based upon the previous year. By creating a deposit for impound accounts at closing, this additional amount helps to pay for any property tax increase or insurance premium.
Sometimes the jump in property taxes is so great from one year to the next there might not be enough funds in the impound account to cover the tax bill. When this happens the lender typically pays the additional amount from their own funds and then adjusts your impound payments. Because taxes and insurance bills will change over time you can expect your impound accounts to be adjusted as well.
Cancelling Impound Accounts
You may also be able to cancel your impound accounts later after you close on your property and in the same manner that mortgage insurance can be waived when the loan balance falls below 80% of the current market value of the home, so too can you waive impounds and have the funds returned to you.
The amount of those funds will vary based upon the time of year and whether or not the lender has recently paid either the property taxes or insurance. As well, lenders are required to provide to you an impound account statement each year which shows the amounts accrued over the past year and the disbursements made. The amount of interest paid will also be listed on this statement.
In today’s environment, there really aren’t that many places to invest that will provide much of a significant return without subjecting funds to the whims of the stock market. When deciding whether or not to take impounds you might want to speak with your financial planner to see if it makes sense to put the money elsewhere. Otherwise, many borrowers appreciate the convenience of impound accounts as well as a lower cost loan.
