When you and your spouse are ready to buy your first home, it's wise to gather as much information as possible about real estate and mortgage transactions. There might be charges at the time of closing that you didn't expect, such as those for reserves. Also called impound or escrow accounts, reserves are collected from you by the lender to ensure timely payments of your property taxes and hazard insurance bills. While this might seem like an advantage to you, there also are disadvantages to consider when your lender is in charge of your funds.
Lenders determine the monthly amount to collect by estimating the annual tax and insurance payments and dividing them by 12. This amount is added to your monthly principle and interest payment. Because these costs can fluctuate, some mortgage companies require borrowers to deposit more than necessary into the accounts. The federal Real Estate Settlement Procedures Act regulates guidelines established for impound accounts. RESPA does not require extra money to be collected but allows lenders to keep up to one-sixth more than they anticipate needing. This equals a buffer of two-months worth of payments. In addition, RESPA does not make mortgage companies pay borrowers interest on the money they hold.
More Money at Closing
The money you bring to the close of your purchase is more than just the amount of the down payment. Many other costs and fees can be included, such as the appraisal, transfer tax, attorney charges, homeowner association dues, loan fees and more. It might seem that, even with the additional costs, the amount required is much more than you anticipated. The cause can be the added impound account reserves needed. Depending on when you close and when your property taxes are due, you might need to pay up to eight months of impounds.
Late or Nonpayments
Although most lenders have systems in place to pay your tax and insurance bills on time, some can fall through the cracks, especially if your mortgage is new. You might not know that your payments weren't made until you receive late notices and are assessed penalties. In addition, some jurisdictions issue supplemental tax bills after a property changes owners. These can be overlooked by your mortgage company. If your property tax and insurance offices send you an informational copy of your bill, follow up with your lender to ensure timely and accurate payments are issued.
Difficult to Cancel
You might prefer to control the money in your reserves and earn a return by opening an interest-bearing bank account. Some lenders do not require that you pay impounds if your down payment is 20 percent or more. Others, though, require it regardless of how much you borrow or can make you pay an extra fee if you are allowed to bypass the payments. Once you have an impound account, it can be difficult to cancel. You might be able to petition your mortgage company after you have at least 20 percent equity in the property, and it will release you from the requirement. If you do not have this option, you might need to refinance the loan to avoid the reserve requirement.
- Loans by Irene: What Is an Impound Account?
- U.S. Department of Housing and Urban Development
- The Orange County Register: Should You Have an 'Impound' Account?
- MCP Help Blog: What Is a Mortgage Impound Account and Do You Have to Have One?
- Bankrate.com: Let Your Escrow Grow for You, Not Your Lender
- EscrowHelp.com: Escrow Impound Accounts: Do You Have a Choice?