Don’t Buy a Home Without Understanding Your Impound Account

This guest post was written by Go Banking Rates, bringing you informative personal finance content and helpful tools, as well as the best interest rates on financial services nationwide.

You’re getting ready to take a huge step forward in your life to buy your first home and everything is going great until your lender brings up the impound account. Impound account? It sounds like a negative thing, but an impound account can be a very important and helpful tool used in the home buying process.

However, there are also a couple potentially serious drawbacks. If you’re thinking about purchasing your first home, you should familiarize with this type of account and determine if it’s something you’re willing to use.

Impound Account Definition

An impound account is also commonly referred to as an escrow account. It’s a separate savings account established by a mortgage lender in order to hold funds that will later be used to pay the property tax and insurance costs on a home. Those are the only two things the money can be used for–taxes and insurance. That means if you’re behind on a mortgage payment or bill, too bad; you have to find the funds you’re lacking elsewhere.

Since property tax and insurance payments can be pretty high and only need to be addressed a couple times a year, people find it’s easier to set the extra money aside at the time they purchase their home, rather than save up for the big expense every six months. Usually, lenders require that an impound account be set up anyway.

How Fees Are Paid From an Impound Account

Property taxes and insurance premiums are only paid a couple of times a year, so the mortgage lender will divide up the yearly cost into equal monthly payments and then deduct that amount from the impound account.

For example, if you must pay $1,200 a year in taxes and insurance, $100 will be deducted from the impound account per month and tacked on to your mortgage payment. In most cases, a lender will require you to deposit several month’s worth of payments into the account ahead of time so there is a decent balance built up.

For this reason, your overall monthly mortgage payment will increase due to the addition of impound account payments, though you really pay for the difference ahead of time.

Why Are Impound Accounts Used?

Lenders prefer that borrowers keep funds specifically allocated for taxes and fees in a separate account to prevent any lapse in payments. Falling behind on these payments could potentially result in a lowered property value.

Rather than count on a borrower to come up with these important payments every month, the impound account ensures they will be met without any problem, even if the borrower runs into financial troubles.

Dividing these costs over a longer period of time can also be of great benefit to the homeowner, too. Budgeting becomes much simpler and all of the costs associated with purchasing and owning a home seem a bit easier to manage.

Potential Problems

As mentioned, the money you put into an escrow account is then kept for the specific purpose of paying taxes and insurance. If you decide later on that you actually need the money you deposited for something else, well, you’re out of luck. Once the money goes in, it stays in until your lender needs it.

It’s also very important to be aware that many impound account balances fall short over time. Taxes tend to go up on a regular basis while insurance premiums generally rise over time as well, which means the amount you originally set aside for these costs may no longer be adequate down the road. Be sure your lender factors these possibilities into the calculation when determining how much you will need to deposit.

One Big Plus Side

Impound accounts can earn interest–pretty good interest, too, considering what traditional savings accounts are offering these days. However, there are a few catches. The rules vary state-by-state, but certain factors like when the loan originated and whether the account was voluntarily opened or required by the lender determine whether it’s eligible to earn interest.

Impound accounts may simplify budgeting and give the you peace of mind that at least one bill is paid up, but if you take issue with losing some control over the fate of your hard earned money, you might want to think twice about committing to loan terms that include one.

Sometimes an impound account requirement can be waived, but not always. Ask about the terms of your mortgage and how an impound, or escrow, account will factor in before you agree to a loan.