Mortgage Impound (Escrow Account) Basics

[jeffrey]

By Teri Newton

If you own a home, you have probably heard of an impound account, sometimes referred to as an escrow account. So what is an impound account anyway, and is it a good idea?

An impound account is an account that is set up so that you pay your mortgage company a monthly amount, which they hold to pay your property taxes and home insurance. Since these bills only come due about twice a year each, many average Americans have a hard time saving for them and gladly give their money interest-free to the loan companies to take care of it. Plus, this just means one less thing for you to worry about. (Or does it? Read on.)

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Mortgage companies are in this for a variety of reasons. First, they get to keep your money interest-free and charge you all sorts of fees regarding impounds whether you use them or not. But frankly this is not the only reason. Mortgage companies have a vested interest in you paying your property taxes on time (to avoid liens) and your insurance on time (to avoid loss). The mortgage companies also know that Americans are terrible savers. So they have devised a solution that seems to please everyone.

Given the choice, I always recommend financially not to have an impound account. As for me, my property taxes and insurance are quite hefty, but I put the required $500 per month aside every month into a high-yield savings account which earns 5.0% APR. The money is always there once the big bills come due, plus I earned some interest. I have never personally understood why it is easier to write a bigger check to the mortgage company, but impossible to write a check to your savings account.

Just know that once it goes to the mortgage company you will not earn interest. Some states require mortgage lenders to pay interest on impounds, but some don't. The interest is not much either way. On the other hand, if you truly don't have the discipline and this is the only way you will get your property taxes paid, I won't knock it. It is better than losing your house. But overall I think it is a worthy financial goal to drop your impounds.

Another reason why I have become so anti impound account in recent years is due to a very different reason. The fact is that whether you pay your property taxes and insurance out of your own pocket or through the mortgage company, it is your responsibility. What you may not know is that the mortgage companies are not on the ball as you think. I have dealt with many clients whose lenders did not pay their bills on time for them (or at all) which creates big headaches. Not only that, but many times the mortgage lenders have had the audacity to ask for the borrower to pay the late fees for their mistakes. I have seen this happen enough times to ever consider entrusting the mortgage company with my most important of bills. To further complicate matters, when a loan is sold or paid off, often the impound accounts are overlooked. I had a relative who paid her homeowners insurance using mortgage impounds. They were very proud to pay off their mortgage rather recently but initially did not think about the home's insurance; that it was their responsibility going forward. It had been long enough for the insurance company to completely drop them due to unpaid bills, without contacting them, but not quite long enough for them to notice yet, when someone tripped in front of their house and threatened them with a lawsuit. You can imagine their disbelief when they called their insurance company only to found they had been dropped with no notice. I am sure they would have realized eventually, threatened lawsuit or not, but when you have had someone else paying your insurance for 30 years, this is what happens all too often.

If I have convinced you to drop your impound account, just know that many lenders will require you to keep an impound account until you build at least 20% equity. You may not have a choice if you put little down on your home. But keep this in mind for down the road as you build more equity.

Also, keep in mind that the time to make the "impound or no impound" decision is when you buy a property or when you refinance. If you decide today to drop your impounds, the lender may charge you a fee. You will have to evaluate whether the fee is worth it or not. Overall with the interest saved and more peace of mind your bills are paid it is probably worth it, but it does depend. The fee is usually steeper during the firt year of your mortgage. Also, when you are shopping for a loan, many lenders will charge you a higher interest rate than the initial quote if you do not set up an impound. The standard is an additional 0.125% to the interest rate. Make it clear from the getgo when you are shopping around with lenders that you do not want an impound and you want to know the interest rates for no-impound mortgages. In the past I have only had a higher interest rate on one mortgage because I did not want an impound account, but I hear that this is the norm today. Just keep in mind that this shouldn't mean you don't have any negotiation power. But if you are having trouble setting up a no-impound mortgage withhout being charged a higher interest rate, enquire about the fees to switch later. It may be worth keeping it for the initial year and dropping the impound soon after. The problem is that mortgage lenders will usually tell you anything, policies change with time, and it may be hard to drop an impound account once you have one.

Whatever you decide about impounds, just keep in mind that no matter who pays the bills, your property taxes and homeowners insurance are your responsibility. If you decide to keep your impound account and let the mortgage company pay your bills, keep a sharp eye on them. In many counties you can look up to see if your property taxes were paid timely, and you can always request notification from your insurance company when the account is paid. Or you can figure out when the due dates are and keep a close eye on your impound statements. Otherwise, if one of your bills is not paid you may not know until it is too late.

[Richardsmith]

Great thread,

Thanks for your useful information and hope to read more from you.
The Mortgage calculator can be used to figure out monthly payments of a home mortgage loan, based on the home's sale price, the term of the loan desired, buyer's down payment percentage, and the loan's interest rate. This calculator factors in PMI (Private Mortgage Insurance) for loans where less than 20% is put as a down payment. Also taken into consideration are the town property taxes, and their effect on the total monthly mortgage payment.

[PPorter99]

Thank you for that post. I have a friend in Iraq right now who is trying to buy a home with his wife (who is here) and they have been asking me questions about impounds (among other things). Obviously we can't sit and discuss it over a beer like we normally would , so sending him a link to this was very helpful and appreciated by both of us. thanks again!

PPorter99

[backtaxpro]

As a CPA I can tell you many people forget to setup an Escrow account with their mortgage company and then they are slapped with a large property tax bill they cannot pay because they didn't save for it. Having your mortgage company pay your property taxes saves you time, headache, and potential penalties and costs if you have to hire a professional later for back taxes.

[sammythesm]

My question is: where are you finding an online savings account that pays a stable 5%? I can only find accounts up to 2%, and even then they are not guaranteed returns...

[mtsen]

good question then, I guess the only answer is SPAM marketing will say they have that ......

[mgkimsal]

big headache messes

I had trouble in PA a few years ago with an escrow account. We got fined for 'late' payment of property taxes. We had some sort of township tax, county tax and a school tax (IIRC) all rolled up in to one bill. My mortgage company had paid it, but the tax processor had sent it back because they wanted 3 separate checks instead of one. They wouldn't process one check.

So, they'd received payment on time, just not in the format they wanted. But instead of telling *me*, or explaining anything to the mortgage company, they simply sent the check back without explanation, where it was promptly lost in the vast machinations of the mortgage company. That took multiple weeks to sort out - the tax processor only worked part time, and didn't generally answer calls when I had time to call.

HUGE headache, and I opt to handle everything myself now.

[Daddy Paul]

escrow accounts are a disaster

Great read! My opinion is escrow accounts are a disaster. First you have to watch them to verify your taxes are paid. Guess what if they don’t pay them on time they pay the penalty out of your account. Secondly you are giving them an interest free loan. I had $3600 in an escrow account after my summer taxes were paid. This was well in excess of any insurance and taxes for the following year. The bank raised my escrow payments almost 100 per month to cover potential increases. I estimated a year later I would have $5100 by the same time next year. I was motivated to refinance and save 2% on my rate. Even after the refinance it took 3 months to get my then over $4000 back from this bank.

[gocubsgo]

Best writeup on the topic I've seen yet. I recently had to make this same decision: I put 20% down and was asked if I wanted to go ahead and setup the escrow account. They definitely seemed to encourage me to do so, but they couldn't really explain the benefit. In fact I discovered that it can take several months to close the account and get my money back if I ever decided to close the escrow/impound account. Absolutely ridiculous. The term "impound" really IS more accurate.

Now, when this post was originally posted, there may have been savings accounts with 5% interest rates. However, just as interest rates on loans have fallen, so have they fallen on savings accounts. At the end of the day banks have to make money, after all...mortgage interest rates will almost always outstrip savings account interest rates. Also, I've read that some escrow accounts used to pay at least a paltry interest, but my lender (a MAJOR lender, btw) offered none and I'd wager most others don't either these days.

As of today you'll be lucky to find a savings account that pays over 1.25%...maybe 2%, tops. STILL, if it's between giving my money to a middleman who offers ZERO interest and that makes it harder for me to track whether my taxes/insurance are being paid in time, versus getting 1.25% interest on my money (hey, it'll buy a few cases of beer at least!) and having direct control and visibility, the decision is simple. The "peace of mind" argument some make in favor of escrow accounts goes right out the window given the reality that YOU, NOT THE MORTGAGE COMPANY, are responsible when they screw up the payments. Who is more likely to react quicker when the local tax rates or policies change: you, or a giant faceless bureaucracy that is absolved of any meaningful accountability? Yeah...pretty obvious.

This simply takes a modicum of discipline by the homeowner. Calculate what you WOULD pay to the escrow account for taxes and insurance, and be sure that for each mortgage payment you make, you pay that tax/insurance amount into your savings at the same time. And convince yourself that money is UNTOUCHABLE. Don't use it to fix your car, don't use it for vacation, don't even spend it on your kids...consider it gone/non-liquid/non-existant/whatever. If you mix it in with other savings, make sure you subtract the appropriate amount each month from your "touchable" balance. I used this same approach when saving for my down payment, and it actually helped make me a better overall manager of my finances. Discipline breeds discipline. But yes, you must take a merciless approach with YOURSELF. Once that money is in that savings account, it's "gone, baby, gone".

If you have the choice, and you're DISCIPLINED, the escrow account really seems a ridiculous concept. You're already paying the lender interest on your loan...do you really want to give them free money so they can earn MORE income at your expense (and your risk if they screw up the tax payments)?