Your escrow account – to impound or not to impound?
In addition to paying the principal and interest payment on your mortgage, you are also responsible for paying property taxes and homeowners insurance (and PMI if you are putting less than 20% down with a conventional loan or MIP regardless of down payment with an FHA loan). Property tax installments are typically billed and due to the county twice per year, and homeowners insurance is most often billed annually. When you are in the process of purchasing a home, you will likely be given the option of establishing an impound account or waiving an escrow/impound account for your property taxes and insurance. In California, the terms escrow account and impound account are used synonymously.
If you elect to establish an impound account for your property taxes and/or insurance, you are choosing to break these expenses up and pay them monthly to your loan servicer in addition to making your principal and interest payment on your mortgage. Your loan servicer will manage your impound account and hold on to the funds until the actual payments are due to the county (for property taxes) and to your insurance company (for homeowners insurance).
If you choose to waive (not establish) an impound account for property taxes and insurance, you will only pay your principal and interest payment to your loan servicer each month. Then, when your property tax and homeowners insurance bills are due, you will be responsible for paying these expenses directly.
Let’s run the numbers on a hypothetical scenario. Let’s say your annual property taxes are $9,000 and your annual homeowners insurance premium is $1,200 per year. If your principal and interest payment is $2,500 per month and you choose to establish an impound account, 1/12th of your annual property tax amount ($750) and 1/12th of your annual homeowners insurance premium ($100) will be added to your monthly payment collected by your loan servicer. The additional $750 per month for property taxes and $100 per month for homeowners insurance would be kept in your impound account managed by your loan servicer.
This would give you a total monthly payment would be $3,350 per month, and your loan servicer would send payment for your property taxes and insurance from the balance in your impound account when the bills come due. If you choose to waive an impound account, your monthly payment would be $2,500 consisting of only principal and interest and then you’d be responsible for paying property taxes and homeowners insurance on your own.
The decision on whether to impound your property taxes and insurance boils down to personal preference. Let’s take a look at the three main considerations in why someone may decide to impound or not to impound.
1. Convenience – Many homeowners feel that it is more convenient to have their taxes and insurance included in their mortgage payment. This way, they do not need to worry about additional bill due dates and multiple payees, and the budgeting for property taxes and homeowners insurance is taken care of for them through their monthly payment. By not impounding, you will need to track the due dates and budget for taxes and insurance on your own. If you prefer the convenience of making one larger monthly mortgage payment to your loan servicer rather than three payments to three different payees for your loan, taxes, and insurance, impounding may be the way to go!
2. Consistency in monthly payment – If you choose to establish an impound account, your monthly payment will include your property taxes and homeowners insurance. However, CA Prop 13 allows the base year value for your property taxes to increase at a rate of 2% per year. Additionally, your local municipality may issue a vote on bond measures or assessments, and if the measures pass it could result in an increase in your property taxes. Finally, your homeowners insurance premium may increase each year as well.
When the lender establishes your monthly payment at the time your loan closes, they will base your payment on your taxes and insurance at that point in time. If you have an impound account and your property taxes and homeowners insurance costs rise over time, it can lead to an increase in your monthly payment or your loan servicer asking you for a lump sum payment to make your escrow account whole and current (or both). If you have a fixed-rate mortgage, your principal and interest payment will never change as long as you have that loan. With no impound account, you pay taxes and insurance on your own, so any increase would be paid out of pocket directly to the county or insurance company without impacting your monthly payment. Waiving an impound account may be suitable for you if you prefer a stable and consistent monthly payment that will never fluctuate – but don’t forget to budget for taxes and insurance on your own!
3. Total funds required to close – If you elect to impound your taxes and insurance, it will result increase the total of your “prepaid costs” (i.e. prepaid property taxes and homeowners insurance) required at closing. This is because your impound account needs to be pre-funded enough to pay your next installment of property taxes and/or next homeowners insurance premium when it’s due. Depending on what time of the year your loan is closing, anywhere from 3-10 months of property taxes and 3-12 months of homeowners insurance may be required to pre-fund your impound account at closing. Using our same example above, this could increase your total prepaid costs by anywhere from $2,550 – $8,700! If you are purchasing a home, this would increase the total amount of funds you need to bring to the table at closing. If you are refinancing your home, this amount would either be tacked onto your new loan amount or you could choose to pay it out of pocket. With this being said, waiving an impound account does not necessarily save you money in the big picture, but it allows you to pay these expenses out of pocket down the road (when they are actually due) rather than paying them (by pre-funding your impound account) at the time your loan closes.
In summary, if convenience is your priority, you may want to go with an impound account. If consistency in monthly payment or using less total funds to close is more important to you, not impounding could be the way to go!
If you are interested in getting pre-approved to purchase a home or you’d like to refinance your existing mortgage, you may complete our user-friendly online application here. Not quite ready to apply, but want to chat through your situation and options? No problem! Click here to schedule a free 15-minute call with our broker/owner, Dan Patty or email us at TeamDan@solcostahomeloans.com. We are here for you whenever you are ready!