If you have a mortgage on your home, it’s likely that you have been confronted with the option of an insurance impound regardless of where you live – El Paso, Milwaukee, Memphis, Minneapolis, Oakland, etc. The impound is a tool for the mortgage bank to hold funds for your home insurance policy such that it cannot be cancelled without their knowledge. While this may be efficient for some homeowners, it can also have some negative implications. Therefore, before you agree to an impound for insurance, you should evaluate all of the pros and cons.
When you take out a mortgage loan to finance the purchase of your home, the lender accepts its interest in your home as collateral for your loan. Should you not repay your loan, the lender can foreclose and take back the house, recovering most of their investment. However, if your home is damaged, the lender is not able to recover as much of its investment. Therefore, the mortgage lender has a vested interest in making sure the collateral is adequately protected. The way they do this is to require you maintain home insurance on the house. As we discussed in a prior blog article, the mortgagee clause allows the bank to recover from your insurance policy in the event of a damage claim.
However, what happens if you stop paying for insurance? Some homeowners may innocently forget to pay their premiums and others may not have the resources if finances become difficult. This places the lender at risk so they will sometimes require you to impound your insurance premiums. The impound is calculated by the insurance company each year as a monthly amount that you pay along with your mortgage payment. The lender then takes over the responsibility for remitting the premium to the insurance company when it is due. Additionally, the lender will usually calculate an advance deposit on the impound. This means they will usually collect two to three- months’ worth of premiums at the outset of the year and keep a cushion of premiums in case you fall behind.
Some homeowners like the idea of spreading out their payment each month while others do not like pre-paying their premiums. Smart money managers prefer to keep the premium payments in their own accounts to earn interest and will pay the insurance company when the premiums are due. Unfortunately, not all homeowners are always as disciplined. Another consideration is that some lenders will make the impound a requirement of offering the mortgage loan or will sometimes offer a better interest rate on the loan if you agree to the impound.
Before you agree to or refuse an impound, you should consider if it’s the right thing for you. If you are disciplined and always pay your bills on time, an impound is probably not for you. On the other hand, if you don’t think that you will earn much interest on such a small amount of premium and your mortgage lender offers a rate discount, you might still come out ahead by agreeing to it.
If you are someone who has difficulty keeping up with bills, an impound is often a good solution. It eliminates a bill to keep track of. In addition to having your policy cancelled if you don’t pay the premium on time, you can be faced with force-placed insurance, which is an even worse outcome in many situations.
The impact of an insurance impound on your mortgage can have varying effects depending on your situation. You should evaluate the pros and cons to make your own decision when setting up a new mortgage loan.