Table of Contents
What are Impounds? | Home Insurance | Property Taxes | 1st Payment Date
Most lenders require an impound account (also known as an escrow account) for all mortgage loans less than a 20% down payment. If you put down at least 20% in a purchase transaction, the impound account is optional. However, many lenders charge an additional fee at closing to opt out of the impound account.
Why do lenders charge extra to opt out of an impound account?
Delinquent property taxes may result in tax liens which take precedence over the mortgage loan. And, expired insurance could result in total loss of the home (the lenders collateral) if the home burns down after insurance coverage has lapsed.
What is an impound account?
Basically, it is a separate account the servicing lender (the lender that handles the customer service and payments for your mortgage) uses to accrue and pay periodic property tax and homeowner insurance payments.
When you have an impound/escrow account, the total housing payment includes the loan principal and interest and a monthly amount for property taxes and homeowners insurance.
The principal and interest portion is paid to the loan and the monthly property tax and insurance is deposited into the impound/escrow account.
Depending on where you purchase real estate, the lender may require flood insurance, hurricane insurance, and/or earthquake insurance. These policies are included in the monthly amounts paid into the impound account, if applicable.
Example:
What an impound account looks like including the periodic property tax payments and insurance payments over a 12 month period:
In the example above, the Starting Balance is the amount collected at closing to fund the escrow account to make the upcoming August property tax payment of $1555.58.
The monthly Deposit of $407.92 is collected for taxes and insurance monthly and deposited into the escrow account. The Balance column shows the accrued balance through the year taking into account the withdrawals for property taxes in August and February and hazard and hurricane insurance in March.
What does all of this mean for you?
In order for the lender to collect sufficient property taxes and insurance to make the periodic payments after initially buying your home, they must collect several months in advance at closing.
Homeowners insurance…
is typically paid annually. You pay for the first year up front at closing of the purchase transaction. Additionally, another 3-4 months of homeowner insurance premium is collected in the impound/escrow account at closing so there are 12 months in the impound account to make the next annual premium payment.
The lender keeps 2 additional months as a cushion in the impound account in case the property tax or insurance premium is higher than expected when actually paid.
For example, if you buy a home to close May 15th, 2023, your first mortgage payment starts July 1st, 2023 (more on this below). At closing, you pay 12 months homeowners insurance at closing and start paying homeowners insurance monthly as part of your mortgage payment beginning July 1st.
The additional 3-4 months the lender collects at closing May 15, 2023 to start the impound account provides enough funds in the account to make a full 12 month premium payment for insurance in May 2024 and have 2 months cushion remaining.
Property taxes…
are due either semi-annually or annually depending on your locality. The lender collects enough at closing to make the next property tax installment plus a few months cushion depending on when the closing occurs in relation to the payment due date.
If the payment is due annually January 1, for example, the lender collects 8 months up front at closing to ensure sufficient funds in the impounds account to make the annual tax payment.
The lender collects 6 months of property tax from the July to December mortgage payments, then the additional 8 months collected at closing to make the 12 month payment plus 2 months of cushion.
Do the amounts collected for property taxes and insurance change?
Each lender performs an annual impound account review to make sure enough funds are collected monthly to make the full property tax and homeowner insurance payments when due. Your total mortgage payment typically adjusts from year to year to compensate for these changes.
When you sell the home, all remaining funds in the impound account are either credited toward your loan payoff (thus reducing how much you owe) or refunded to you separately post-closing.
Why does the first mortgage payment start July 1st if the closing date is May 15th?
Mortgage interest is paid in “arrears,” meaning the interest paid covers the previous month’s accrued interest. Your July 1st payment covers all of June’s mortgage interest but since you are not making a June payment, you prepay the prorated remainder of May’s interest at closing (in Hawaii, you pay interest from the date of loan funding and the closing date is actually 2 business days later).
Are property taxes and insurance considered closing costs?
Ultimately, prepaid items such as upfront property taxes, homeowners insurance, and mortgage interest are not fees or actual closing “costs” but included in the other closing costs to calculate your total amount due at closing.
Keep in mind not all of the closing costs are fees, some of the line items are things you pay in advance to setup your new loan, which will start 30-60 days after closing.
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