Impounds is a term every homebuyer should know. explains it.

What are impounds?

Impounds, also called impound accounts or escrow accounts, are used to hold money to pay for property taxes and insurance. A mortgage lender sets up the account and adds the taxes and insurance to the property buyer’s monthly mortgage payments. That money is swept into the impound account until the taxes and insurance are due.

Deeper definition

Impound accounts protect lenders by ensuring that mandatory costs such as insurance and taxes are paid. If an owner doesn’t pay these costs, he could lose his home or have a lien placed on it, which jeopardizes the mortgage lender’s investment in the purchase. This is one reason an impound account is often required for homebuyers who make a down payment of less than 20 percent. They’re considered more high-risk than buyers who pay 20 percent or more.

If the lender does require an impound account, the company will manage it and pay the fees on the borrower’s behalf. If, for some reason, the lender doesn’t pay the taxes or insurance, the mortgagee is held responsible and could face penalties — or even foreclosure.

If the lender doesn’t require that the buyer’s property taxes and insurance be paid from an impound account, the buyer is responsible for paying those costs. They’re typically due once or twice a year, so money must be set aside for them.

Impound example

Jack’s home is worth $250,000 and he pays about $2,000 a year in property taxes and $1,000 a year in homeowners insurance. That’s an additional $3,000 a year in property expenses. Jack made only a small down payment on his home, so his mortgage lender divided $3,000 by 12 and added $250 to Jack’s monthly mortgage payments. The lender directs the extra $250 per month to an impound account. When Jack’s insurance is due, the lender sees that it’s paid. Same with his annual property taxes.

Check out the pros and cons of having an impound account to pay for taxes and insurance.

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