When renters desire to become home buyers, they quickly learn once in the mortgage process that their single rent payment will morph into “PITI” or “principal, interest, taxes and insurance,” or a “total monthly housing payment.” So, yes, there are additional monthly expenses to consider when you become an owner. Historically, ownership has bestowed tax benefit on the buyer and that’s been an offset to the higher cost of ownership and because of this, the “rent vs. own” calculation has been used to more fairly compare the cost of putting a roof over one’s head. Rent may be simpler, but ownership is more comprehensive, if more expensive.
Let’s assume that our buyer has done the comparison and decides to move forward with purchasing a place of his own. At some point, his or her mortgage lender will offer a choice (or maybe not…) about how they will pay their property taxes and homeowner’s insurance. There will be two options:
- Waive impounds. The owner foots the property tax bill and insurance premium when due.
- Impound or “escrow” taxes and insurance. The lender creates an account through which the borrower pays 1/12th of the tax and insurance bills along with the principal and interest payment (P&I) each month. When the bills come due, the lender pays them instead of the borrower.
What does this mean, how does it work and which is better? Let’s look at all three in plain language.
What Is an Impound Account?
As outlined above, “escrows” or “impounds” are a financial account where your loan’s servicer can collect, hold and disburse your property tax and homeowner’s insurance payments. The servicer maintains this account and documents it on your monthly statement. Escrow accounts are required on government loans, such as FHA and VA, but are elective in many other cases. Here in California, escrow accounts are required on a loan-to-value (LTV) of 90% or greater. Interestingly, in most states across the country, escrow accounts are customary (if not required). But here in CA, it is more common not to have an escrow account. Go figure…
How Does an Impound Account Work?
Escrow (aka, “impound”) accounts are “pre-funded” at the time of purchase and thus can make your settlement more costly. Why is this? Let’s look at California’s property tax year. It runs from July 1 through June 30. Let’s say you close on your home purchase on June 30. You will live in the house from July 1, forward, but you won’t make your first payment on the mortgage until August 1 because unlike rent, mortgage is paid in arrears. Our first installment of taxes is due November 1 and for a six month installment (July through December of the fiscal year). But note that if your mortgage payments start on August 1 and you have to pay your first installment on November 1, you will have only made three payments by the time the tax bill is technically due for six. Unless the servicer “pre funds” at least three months at close, it cannot cover your installment. This is why you’ll see a number of months of taxes and insurance added to your closing when you have a loan with an impound account. It’s important to note that even though your ongoing mortgage payments continue to add a fraction of your total tax and insurance bills each month, your servicer does not pay the county or the insurer monthly. They pay when the bill is due, just like those borrowers who waive an impound account.
Which Is Better, Taking or Waiving Impounds?
As mentioned, some loan types require impounds. Where that happens, buyers must carefully consider and accept the payment requirement. If there is a choice, it comes down to personal preference and budgetary discipline. Those who waive an impound account do have a smaller monthly expense to cover because they are only paying the principal and interest portions of their total monthly housing expense. When their insurance and tax bills inevitably come due, they have to be prepared to pay them in full, and that requires budgetary discipline on their part throughout the year — just as if the loan servicer was requiring allocations for these expenses. So like with most things in the mortgage industry, there are pros and cons but there is no free lunch. No matter how you opt to pay it, your tax and insurance bills will be the same and must be paid in full at the end of the day.
If you have additional questions about escrow accounts for property taxes and homeowner’s insurance, get in touch any time. As you can see, there are instances where using or foregoing an escrow account comes down to a choice. If you’re wrestling with the best fit for your situation, it often helps to remove the myths and emotions from the decision making process. We can help you do that and get the facts and math straight, and from there, the choice to take or waive escrows often becomes so much more clear.
Paid in full,
Robert J. Spinosa
Vice President of Mortgage Lending
Marin Office: 324 Sir Francis Drake Blvd., San Anselmo, CA 94960
Berkeley Office: 1400 Shattuck Ave., Suite 1, Berkeley, CA 94709
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