When do you need an impound account for a mortgage?
What is an impound account?
Before we explain when you need an impound account it is important to define what an impound account is. Simply put, an impound account is a trust account managed by your lender that is used to pay certain expenses such as property tax, homeowners insurance and mortgage insurance, when they are due. Please note that the lender controls the account but receives no financial benefit, including interest payments, from the account. Impound accounts are also referred to as escrow accounts depending on your location.
When are you required to have an impound account?
Lenders require borrowers to have an impound account if your loan-to-value (LTV) ratio (the ratio of your mortgage amount to the value of your property) is greater than 90% at the time your loan closes, which means almost all low down payment programs require impound accounts. Government-backed programs such as FHA, VA and USDA mortgages also require impound accounts.
In short, the lender wants to make sure that you pay certain costs so they require you to make smaller payments every month instead of making one or two larger payments over the course of the year. They believe this approach helps borrowers avoid potential default or other financial hardship if they miss a property tax or homeowners insurance payment.
You can also request to have an impound account set-up when you apply for your mortgage. Some borrowers find that paying for significant cost items a little every month helps them better manage their finances. In some cases you may receive a small discount on your mortgage terms if you elect to set-up an impound account.
What is deposited into an impound account?
When you get a mortgage in addition to your monthly mortgage payment, you are required to pay other housing-related costs including property tax, homeowners or hazard insurance as well as other potentially applicable monthly costs including private mortgage insurance (PMI), FHA mortgage insurance premium (MIP) or USDA guarantee fees.
Depending on your loan program and LTV ratio, you may be allowed to pay some these cost items directly instead of including them with your monthly mortgage payment. For example, you pay your property tax directly to your local government and your homeowners insurance premium directly to the insurance company when those bills are dues.
If you have an impound account, however, the monthly payment you make to your lender includes all of these fees in a single payment. That is why these additional costs are sometimes referred to as impounds.
If you have an impound account, your monthly check or automatic payment is deposited into the account. The lender collects the interest and principal they are due that month according to the terms of your mortgage and the remaining funds are used to pay the other cost items when due. For example, funds build up over the course of the year to pay your property tax on a semi-annual or annual basis as well as your homeowners insurance and other authorized expenses, when those payments are due.
Additionally, when your mortgage closes you may be required to deposit funds into your impound account to pay for the first property tax and homeowners insurance bill due after your loan closes plus an extra buffer. So depending on when these bills are due and if they are payable on an annual or semi-annual (every six months) basis, you may be required to prepay up to 15 months of these costs at closing.
Also known as prepaids, these recurring closing costs make sure that you have enough money in your impound account to pay for these expenses and also account for any potential cost increases for these items. Your lender is required to audit your impound account once a year and any leftover funds in your account after a year should be credited to you or deducted from your principal loan balance.
How are impound payments calculated?
Your impound payment is based on the estimated cost of the items the lender is authorized to pay from the account. For example, the lender uses your property tax bill and homeowners insurance statement to estimate the property tax and insurance payments you include as part of your monthly payment.
Although items such as property tax and homeowners insurance may be paid semi-annually or annually, your monthly payment is high enough so that there are sufficient funds in your impound account to pay those expenses when due.
If your property taxes, homeowners insurance premium and other authorized costs increase, your monthly impound payment should increase as well. If these costs decrease for some reason (such as if PMI is removed from your mortgage) then your monthly impound payment should decrease.
In an ideal scenario the lender collects just enough funds to pay the exact cost of the items that are paid out of the impound account. If the lender does not collect enough money to pay the expenses -- for example if your property tax rate increases over the course of the year -- then your impound account becomes deficient and your monthly payments could increase, at least temporarily, to correct the deficiency.
If the lender collects more money than is required to pay the items due from the impound account then the account has a surplus. In this case your monthly payment may decrease. It is important to highlight that under no circumstances can the lender keep or take any extra funds in your impound account.
What if I think my lender made a mistake with my impound account?
If you believe your lender made a mistake, such as overcharging you, you can request an audit of your impound account. An audit enables you to review a detailed monthly history of all deposits into, and payments made from, your impound account. You can then compare the impound account payment history to your bills and account statements for each specific cost item.
If you find a significant discrepancy, you can use this documentation to ask the lender to correct this issue. If the lender is unwilling to address the problem then we recommend that you contact a real estate attorney, your state attorney general or the Consumer Financial Protection Bureau to look into the matter.
Sources
“What is an escrow or impound account?” CFPB. Consumer Financial Protection Bureau, August 3 2017. Web.
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