When you buy a home or refinance, your lender will talk about setting up an “escrow” account. They may also refer to the charges in that account at “impounds.” If you are new to mortgage loans, you may not understand what these terms mean. And even if you’ve been around the mortgage block a few times, you may wonder if you’d be better off handling the impounds yourself.
What are Escrow Accounts and Impounds?
Escrow is a third party-managed account that collects money for your property taxes and homeowner insurance, paying them off when the bills come due. These fees are called impounds; you will likely be required to deposit one or two months’ worth of mortgage in the account at closing to provide a buffer for tax or insurance premium increases. For future debts, the escrow company will break the once-yearly fees into 12 equal chunks, adding them to your monthly mortgage payment. When you look at your home loan statement, you may see the acronym “PITI,” meaning principle, interest, taxes, and insurance. This is an indication that you are paying for all four charges with each payment.
Who Benefits?
These accounts give lenders assurance that you will be able to pay those large bills when required. Americans on average have little or no savings on hand, and left to their own devices, many would not have enough cash on hand to cover those expenses in one lump sum. By splitting the cost up over 12 months, lenders reduce the risk of defaults due to unpaid taxes and insurance bills. Lenders are actually the owners of the property until you fully repay the loan, so if you default, they stand to lose the most.
While escrow or impounds certainly benefit your lender, they can obviously help borrowers as well. The escrow company takes care of collecting the money, keeping track of when the bills are due, and paying them on your behalf. They are also required to review your account annually and if they over-estimated the yearly amount, you will receive a refund check. It is also possible they may ask for extra if the taxes or insurance increased unexpectedly.
Why Pay on Your Own?
Some borrowers are confident they can handle the impounds on their own. Financially-savvy people might try to be uber-accurate in estimating the costs, so that they can hold onto any overages. It is the same principle as lowering your withholdings on your taxes; you may not get a big refund once a year, but you will have been in control of more of your money throughout that time. You should be aware that “waiving impounds” usually comes with fees. You could be charged between 0.125% and 0.25% of your loan balance. For a $250,000 loan, that would be in the range of $300 to $600. It may be possible to roll that cost into your loan total by paying a slightly higher interest rate. Just a heads -up, that option could end up costing much more over the course of the mortgage.
Not all states and mortgages allow you to take over your own escrow. Government-backed loans like FHA, VA, and USDA require impounds. And conventional loans guaranteed by Freddie Mac and Fannie Mae require impounds until you reach 20% equity in your property. There still may be a fee associated at this point.
Is It Worth It?
In most cases, it is must easier and safer to let an escrow company handle your tax and insurance bills. However, in either case, you are ultimately responsible for those payments and should perform your due diligence each year to make sure they are paid.
Do you have another mortgage question? If so, let us know at 408-879-9000 .