Did you think that when you stopped renting and started owning your home, you'd finally be done with deposits? Think again. When you buy a residence with a down payment of less than 20%, your lender may require you to make a deposit on your homeowners insurance, private mortgage insurance, any required additional insurance (like flood insurance), and your property taxes. Even if you have a down payment over 20%, your lender may still require you to have an impound account.
How It Works
An impound account (also called an escrow account, depending on where you live) is simply an account maintained by the mortgage company to collect insurance and tax payments that are necessary for you to keep your home but are not technically part of the mortgage. The loan servicer divides the annual cost of each type of insurance into a monthly amount and adds it to your mortgage payment.
An impound or escrow account is essentially a form of forced savings. Annual property taxes and home insurance premiums can be significant expenses. Including these costs in a monthly payment to your lender forces you to save so that these expenses are covered.
Required Mortgage Impounds
Lenders consider borrowers who make low down payments to be riskier. By having less of their own money in the property, their likelihood of default is higher than that of borrowers with more equity in their homes. In this situation, lenders require mortgage impound accounts.
These accounts prevent the local property tax authorities from foreclosing or putting a lien on the property in the event of non-payment of property taxes. An impound account also protects the mortgagee's collateral from major damage by ensuring that homeowners insurance is paid.
Optional Mortgage Impounds
Even if your lender doesn't require an impound account, you may be able to opt in at the loan signing. But is that a good idea?
An optional mortgage impound account locks up money that you might prefer to hold elsewhere. Not all states require loan servicers to pay interest on the funds held in impound accounts, and those that do may not pay as much as individuals could earn by choosing a high-interest savings account.
Further, if the mortgage company does not properly use the impound account to pay your bills—like property taxes and homeowners insurance—when they are due, you will still be on the hook. Homeowners should be aware of the due dates for these payments and monitor their impound accounts carefully.
Although the impound account is designed to protect the mortgagee, it can also be beneficial for the borrower. By paying for essential housing expenses gradually throughout the year, you can avoid the sticker shock of paying large bills once or twice a year and be assured that the money to pay those bills will be there when you need it.
An optional impound account might be a good idea if you don't trust yourself to set aside money for property taxes and homeowners insurance and leave it untouched until the bills are due.
Monitoring Your Impound Account
Your monthly mortgage statement should show the balance in your impound account, making it easy for you to keep a close eye on it. Federal regulations also help protect you: they require mortgage servicers to review borrowers' impound accounts annually to make sure the correct amount of money is collected. You should get an annual statement showing the results of this review.
If your servicer has been asking for too little, or if your insurance or tax bills have gone up, your servicer will increase your monthly impound payment. If too much money is accumulating in the account, the servicer must return the excess funds to you and adjust the monthly payment to the correct amount.
When you have a fixed-rate mortgage, your monthly payments of principal and interest are the same for the life of the loan. However, because homeowners insurance and property taxes often increase each year, your monthly payment to your impound account can go up. It's important to know about these increases so you can prepare for them.
Required impound accounts decrease the amount that borrowers may have available to place in an emergency fund. The servicer keeps an extra cushion in your impound account to keep making insurance and tax payments if you stop making your monthly mortgage payments. This cushion is collected when you take out your loan.
Essentially, the startup costs associated with impound accounts can increase the amount of cash you need in order to buy a home in the first place, and decrease how much you can keep in a savings account you have control over.
Buyers don't need to maintain impound accounts forever, though. Once you have enough home equity (often 20%), your servicer may drop your impound requirement if you ask them to.
How Do an Impound Account and an Escrow Account Differ?
Impound accounts and escrow accounts are the same. They are referred to differently based on where you live and the lender you use.
What Are the Downsides of an Impound Account?
The biggest downside of an impound account is that you don't get the option to earn interest on the money in the account if you live in a state where mortgage servicers aren't required to pay you interest on it. An additional downside is a change in your monthly mortgage payment as property taxes and premiums go up, but this change to your budget would still occur without an impound account.
What Are the Upsides to an Impound Account?
The biggest upside to an impound account is forced savings that ensure your property taxes and homeowners insurance premiums are paid on time. If you leave the savings up to yourself and aren't diligent about budgeting for them, you can be faced with a huge bill you're unable to pay and could lose your home as a result.
The Bottom Line
For many homeowners, mortgage impounds are a necessary evil. Without them, lenders might not be willing to give mortgages to borrowers who can afford only low down payments. The best way to deal with impound accounts is to understand how they work, monitor them carefully, and get rid of them when you can if you prefer to save for these expenses separately.