The question of tax and insurance impounds is one I usually get, even from experienced buyers. There are mixed thoughts on the matter.
Your payment is made up of 4 components. Principal, Interest, Taxes, and Insurance.
If you are required to also have Mortgage Insurance (as opposed to property insurance) then that will be the 5th component. I will address Mortgage Insurance in tomorrow's post).
If your downpayment is less than 10%, lenders will require you to have your taxes and insurance impounded. This means that 1/12 of your annual property tax bill + 1/12 of your annual insurance premium will be added to your monthly payment. The lender will hold this portion of your payment in an impound account.
Some borrowers prefer this for convenience while others want to pay their property taxes and insurance premium on their own. Here's what you need to think about in order to determine if an impound account makes sense for you.
1. Are you a good saver?
If you aren't good at saving money, you'll be in trouble when it comes time to pay your taxes and insurance.
Property taxes are due twice a year. November 1 (late after December 10) and February 1 (late after April 10). Although these dates are not six months apart, each payment will be half of your annual tax bill.
Your insurance premium due date depends on your insurance company. Lenders always require a full year of insurance coverage be paid in full when you purchase a home but for subsequent years it's up to your insurance company. Many allow quarterly or even monthly payments. It's important to know that if your homeowners' insurance lapses (because of non-payment or cancellation), your lender will automatically add insurance for you and it is always very expensive.
Why put tax and insurance impounds in your lenders account when you put them in your own?
2. Will you get a better interest rate if you decide to let your lender set up an impound account?
It used to be the case that a lender would give you a slightly lower rate or charge you very slightly less in closing fees, but this is generally no longer true.
What is most important for you to know is that the initial funding of your impound account can be expensive. Depending on when your loan closes and your first payment is due, the amount required by the lender to initially fund your impound account can be substantial. The lender always wants to have a cushion. They do this by starting your account with 2 months of payment for your insurance. Property taxes will be 2 months plus the number of months until your next tax bill is due.
Confusing? Take a look at this chart to see just how big a number it might be, based on your closing date.
In the infrequent case when the lender slips up and doesn't pay your taxes on time, they are responsible for any penalties.
3. What should you do to be certain you can make these payments on time?
Unless you have substantial amounts of accessible savings, I suggest you open a separate savings account and deposit 1/12 of your property taxes into it each month at the same time as you make your principal and interest payment to the bank. The same goes for your homeowners' insurance unless your insurance company allows you to pay monthly. Why put tax and insurance impounds in your lenders account when you put them in your own.
Another note on property taxes.
When you purchase your home, the County Accessor's office usually hasn't had time to levy the new tax amount. Since your base tax rate for California is 1.25% of the purchase price, that's all you have to go on when you first take ownership of your home. However, cities, municipalities, counties, each have their own Supplemental Tax levies. These can be for schools, new sewers, – all sorts of things. Some are temporary, some not. You will receive a Supplemental Tax bill once the Accessor gets caught up. Keep an eye open or it. It will tell you specifically what it is for, how much you own and when it is due. The second year you own the home it will be included in your regular tax bill.
This is important because if your taxes are being impounded, the lender will not get that supplemental tax bill, you will. Even though the lender is paying your taxes for you, the won't know about that supplement the first year, so be sure to pay it.
My Two Cents Worth
I would never allow the bank to pay my taxes and insurance for me. They sometimes make mistakes and why should they have the use of my money? You're better off earning the interest in your own savings account.
That said, there are some types of mortgages that you won't have a choice. Always ask.