Did you think that when you stopped renting and started
owning, you'd finally get your deposit back for good? Think again. When you buy
a house 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.
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 lender divides the
annual cost of each type of insurance into a monthly amount and adds it to your
mortgage payment.
Required
Mortgage Impounds
Since low down payment borrowers are considered to be a
higher risk due to their lower personal stake in the property, lenders want
some level of assurance that the state will not seize the property because of
non-payment of property taxes, and that borrowers won't be without homeowners
insurance in the event that the property is damaged. An impound account ensures
that the only person who will become owner of the house in case of default will
be the lender.
Optional
Mortgage Impounds
Even if an impound account is not required, one can be
elected at the loan signing. But is that a good idea?
Some consumers would rather set money aside in a
high-interest savings account, and feel that impound accounts are a bad idea.
Not all states require lenders to pay interest on the money held in impound
accounts, and those that do may not pay as much as individuals could earn by
investing the money on their own.
Further, if the mortgage company does not pay bills - like
property taxes and homeowners insurance - when they are due, the homeowner will
still be on the hook. Therefore, 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
lender, it can also be beneficial for the borrower. By paying for big-ticket
housing expenses gradually throughout the year, borrowers avoid the sticker
shock of paying large bills once or twice a year, and are assured that the
money to pay those bills will be there when they need it.
Monitoring
Your Impound Account
Your monthly mortgage statement will probably show the
balance in your impound account, making it easy for you to keep a close eye on
it. Federal regulations also help borrowers out in this area by requiring
lenders to review borrowers' impound accounts annually to ensure that the
correct amount of money is being collected. If too little is being collected,
the lender will start asking you for more; if too much money is accumulating in
the account, the excess funds are legally required to be refunded to the
borrower.
Additional
Considerations
The cash amount that fixed-rate borrowers think of as their
monthly payment is still subject to change – this is one of the biggest issues
with impound accounts. Since homeowners insurance and property taxes are
subject to change, monthly payment amounts can fluctuate, affecting monthly
cash flow with little warning.
Required impound accounts also decrease the amount of money
borrowers can place in an emergency fund. The lender keeps a little extra in
your impound account, in order to ensure the extra cushion needed in order to
keep making insurance and tax payments if you stop making your monthly mortgage
payments. This cushion is collected when you acquire the loan. Thus, the
startup costs associated with impound accounts can increase the amount of cash
buyers need in order to purchase a house in the first place.
Low down payment buyers don't need to maintain impound
accounts forever, though. Once sufficient equity (often 20%) is achieved,
lenders can often be convinced to ditch the impound account.