Impound accounts, called escrow accounts in some parts of the country, are set-aside accounts used to pay property tax bills and insurance premiums when due. Each month when someone makes a mortgage payment and there are impound accounts set up, 1/12th of the annual tax bill and 1/12th of the insurance premium are included with the mortgage payment. These funds are set aside and kept by the loan servicer. Depending upon the lender, setting up an impound account might mean one or two months of tax and insurance installment payments are made to set up the impound account. Other lenders may not require any impound account to be set up when the new loan initially funds.
The loan servicer is the company that collects the monthly payments and distributes them to the proper place. Your principal and interest payment pays down part of the outstanding mortgage balance while the interest heads to whoever owns the loan. With a conventional loan, that entity receiving the interest payments is typically either Fannie Mae or Freddie Mac. When you write your check each month for the mortgage payment, it’s going to the servicer.
With regard to taxes and insurance, the servicer holds onto the monthly tax and insurance installments and pays when due. The service receives the billing statements both from the taxing authorities as well as the insurance company and pays accordingly. In this fashion, the homeowners don’t have to pay the big tax bill or insurance premium when due but instead makes monthly payments. Much like taking out an auto loan. Instead of paying cash for the car when purchased, the payments are broken down into monthly installments making the car more affordable.
Impound accounts are required with government-backed loans such as VA, FHA and USDA loans. These accounts are also required with conventional loans when the first mortgage is more than 80 percent of the value of the property. Homeowners don’t have a choice in these situations but they do with a conventional mortgage when the first lien is 80 percent or lower than the value. In this situation, is it better for someone to choose impound accounts?
It’s really a matter of personal preference. There are those that would rather pay just the principal and interest payment each month and keep an amount in the bank to pay the property taxes and insurance when due. In this way the monthly payments are lower with a boost to cash flow.
On the other hand, homeowners may like the convenience of not having to pay the taxes and insurance in one big lump sum every six or twelve months, whenever they’re due. This method also insures the property taxes are always paid and the property is never left without coverage. When someone doesn’t have impound or escrow accounts and doesn’t pay taxes or insurance when due, the servicer is alerted as such. The homeowners are notified that taxes are delinquent or insurance has lapsed or about to, the servicer can then “force place” impound accounts which means from that point forward, each month’s payment will have an amount for taxes and insurance. There is no longer a choice. Further, force placed insurance polices are much more expensive compared to someone using an independent insurance policy.
For those that don’t have a problem paying tax bills and insurance premiums on their own, forgoing impound accounts is typically the option taken. For others who would rather make smaller monthly payments and let the servicer take care of the insurance and tax bills, setting up impound accounts is the preferred approach.