In some regions they’re called escrow accounts while in others they’re referred to as impound accounts. Either way, they’re essentially one and the same. An impound or escrow account is an account set up to regularly deposit a portion of the annual or semi-annual property tax bill and for renewal of an insurance policy. A mortgage payment includes an amount that goes toward the outstanding loan balance, or principle, while the remainder goes toward interest due the lender. Over time, the loan balance is paid off.
For those who also want to escrow for taxes and insurance, 1/12th of the annual tax bill is paid and held by the lender’s servicer. Each month, that amount increases and when the tax bill comes due, the lender pays the tax bill on behalf of the borrower. The same goes for an insurance policy. If an annual insurance policy is $1,200, then each month the monthly amount is $120. When it’s time for the annual renewal, the lender then renews the policy using the funds paid each month. The borrower needs to do nothing other than making the monthly payment. Should you create and escrow account to have the lender automatically pay your property taxes and insurance?
The first answer depends upon the amount of your initial down payment or equity position. For loan balances that exceed 80% of the value of the property, homeowners don’t have a choice. Lenders require escrow accounts when the loan balance surpasses this 80% level. This is an automatic when it applies to government-backed loans.
These loans are those guaranteed by the VA, FHA and USDA. VA and USDA loans don’t require a down payment and in so doing escrow accounts are a must. FHA loans, with a typical minimum down payment of 3.5% also require escrow accounts. With these loans, taxes are paid and insurance renewed automatically when due. Borrowers do nothing other than establishing a new escrow account. Some lenders require an initial deposit when creating a new escrow account, such as one or two months of payment.
Okay, so what if the down payment is more than 20%? It’s at this stage where the homeowners do indeed have the option of creating an escrow account. But, given the choice, should you? This is a personal choice. Some borrowers like the convenience of having their property taxes and insurance paid for automatically. Doing so means not having to come up with a large annual payment at the end of the year but instead the taxes and insurance are paid for via the escrow account.
Still others prefer to make their tax and insurance payments on their own. Homeowners may want to tap into their bank account when it’s time to pay the tax bill and insurance premium, keeping their money in the bank or in an investment account. But really, it’s nothing more than a preference. Personally I had always set up an escrow account when I bought a home, even with a good amount of equity in the property in the form of a down payment. It’s a convenience factor knowing the taxes and insurance are paid for automatically.