What it means
When you take out a mortgage, the lender wants to be sure that property taxes and insurance premiums are paid, because unpaid tax or an uninsured house puts its security at risk. Rather than leaving you to find a large bill once or twice a year, the lender adds a monthly amount to your payment and keeps it in an impound account, also called an escrow account.
When the bills arrive, the lender pays them for you. For the borrower, the benefit is budgeting.
A yearly tax bill of several thousand dollars is spread into twelve smaller instalments, which makes cash flow easier to manage. There is no interest paid on the balance in many arrangements, so the money is not working for the borrower in the meantime.
The monthly amount is based on the expected annual bills. Lenders review the account once a year and adjust it if taxes or insurance premiums have gone up or down.
They may also hold a small cushion, which is an extra amount kept in case a bill is higher than expected, within limits set by law. Some loans require an impound account, particularly where the borrower has a small deposit, and others make it optional.
Borrowers who are disciplined at saving sometimes prefer to pay the bills themselves, so they keep the money in their own accounts. In that case the lender may charge a fee or a slightly higher rate.
In a different setting, to impound means to seize and hold property, such as a vehicle or documents, until a debt, fine or dispute is resolved. A business might see this when a customs authority holds a shipment, or a court orders assets held pending a decision.
In both senses the idea is the same: money or property is held by a third party and used only for a stated purpose. The borrower or owner should therefore ask what the money is for, when it will be used and how any surplus is returned.
In practice
Real-world examples.
Example
A family buys a home with a small deposit. The lender requires an impound account, adding $650 a month to the mortgage payment. When the property tax bill arrives in the autumn, the lender pays it from the account.
Example
A small property investor with several rentals prefers to manage his own cash. He negotiates with the lender to waive the impound account and pays taxes directly. He sets aside the money in a separate savings account each month so that bills are never missed.
Example
A freight company has a shipment held at a port because of a paperwork dispute. The customs authority impounds the goods until the correct duties are paid. The company's finance team pays the amount owing to get them released.
Formula
Calculation
Monthly impound = (Annual property tax + Annual insurance premium) / 12
Suppose a home has an annual property tax bill of $6,000 and an annual insurance premium of $1,800. The yearly total is 6,000 + 1,800 = $7,800.
Dividing by 12 gives a monthly impound of 7,800 / 12 = $650. If the borrower's loan principal and interest payment is $2,000, the total monthly payment to the lender is 2,000 + 650 = $2,650.Case study
Seen in the real world.
Willowbrook Properties is a fictional landlord with six small houses, each with its own mortgage. Two of the loans had impound accounts and four did not.
The finance manager noticed that the four loans without impounds caused an annual scramble to find about $28,000 for tax and insurance bills in two months. She asked the lenders to convert them into impound accounts, adding about $2,333 a month across the four properties.
In this illustrative case the monthly payments were higher, but the cash flow became smooth and the company stopped using an overdraft to cover tax bills. She also reviewed each annual statement to check the lender's calculations.
Watch out
Common mistakes.
- Forgetting that the impound is part of the monthly payment, and judging a mortgage by the loan payment alone.
- Being surprised when the payment rises, even though the lender recalculates the amount when taxes or premiums change.
- Assuming the money in the account belongs to the lender, when it is held for the borrower's bills and any surplus is usually refunded.
Questions
People also ask.
Is an impound account the same as an escrow account?
In mortgage lending the terms are usually used interchangeably, although the word escrow is also used for other kinds of arrangement.
Can I cancel an impound account?
Sometimes, if the loan terms and the lender's rules allow it, for example when the borrower has built up enough equity.
Why did my monthly payment go up?
The most common reason is a rise in property tax or insurance, which makes the lender increase the monthly amount collected.
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