How to Handle Impound Account Shortages
Impound Account Options and Choices
Impound accounts, or escrow accounts as some mortgage lenders refer to them, are confusing for many homeowners. In addition, next to payment increases due to rate hikes on an adjustable mortgage, a major unexpected headache facing many homeowners is how to handle an impound account shortage. Because impound accounts will fall short. They always do. It's a fact of life when taxes increase annually and insurance premiums go up.
The Escrow or Impound Accounts
In some parts of the country, these accounts are referred to as escrow accounts. The terms are used interchangeably. Impound Accounts are separate savings accounts set up by mortgage lenders to pay property taxes and property insurance on behalf of the homeowner. The lender collects a monthly amount equal to about 1/12th of the total sum due.
Example of an Impound Account Payment
If the taxes are $1200 a year, the lender will collect $100 per month. If the insurance premium is $600 per year, the lender will collect an additional $50. This $150 impound account payment is then added to the regular principal and interest payment to equal a total payment and is known as total payment principal, interest, taxes, and insurance (PITI).
Setting Up an Impound Account
Lenders always want a few months of impound dollars in reserve. Say, your taxes and insurance portion of your monthly mortgage payment is $150 per month. The lender might require the account to hold $300 as a safety net.
On top of that, when the impound accounts are originally established, the insurance premium is paid upfront but the taxes are not. Typically, taxes are paid when they come due. Each state controls the exact due date and some states require homeowners to make scheduled payments.
If taxes are coming due, say, in November, and your loan is closing in September, the lender could very well require seven or eight months of impounds to be paid at closing.
How Shortages Happen
If a loan is completely amortized at a fixed rate of interest, the principal and interest payment will never increase or increase. However, taxes do increase (they rarely fall). Insurance premiums are increased based on complex formulas from insurance companies. But insurance policy coverages sometimes go up as well because it costs more every year to rebuild a home in the event of a disaster.
Sometimes lenders do not compute the initial funding correctly and will notice that if they continue to collect the same initial sum from the borrower, there will not be enough money in the account to pay the bills when the bills become due.
How You Can Fund a Shortage in an Impound Account
Generally, you have several options.
- Shop for less expensive insurance
- Lower insurance coverage (not recommended)
- Pay the difference in cash
- Agree to pay the increased payment
If you pay the difference in cash, you will continue to pay lump sums into your impound account for the life of your loan because the lender will need that money, whether it's paid monthly or all at once, to pay taxes and insurance. Given the value of time and money, it is better to pay the increased payment because your out-of-pocket costs are then spread over a number of months, reducing the cost of money. Remember, a dollar today is worth more than a dollar six months from now.
Establishing Your Own Impound Account
If you have the discipline to save a monthly amount to pay your own taxes and insurance, then setting up a separate savings account for this purpose might make sense for you. Be aware that if your loan balance is more than 80% of the value of your home, your lender may not allow you to maintain your own account. Plus, if your taxes go up at the end of the year, you will then pay your own impound account shortage in one lump sum.
Sometimes lenders charge 1/4 of a point more to borrowers who wish to control their own impound accounts when you get a new mortgage. You should ask about it. Because you might not wish to pay a higher interest rate just for the privilege of managing your own impound account.
At the time of writing, Elizabeth Weintraub, CalBRE #00697006, is a Broker-Associate at Lyon Real Estate in Sacramento, California.