When you’re dreaming about your new home—especially if it’s the first one—the last thing on your mind is an impound account. But impound accounts (known as escrow accounts in some states) are often one of the largest portions of your total closing costs.
To help you understand everything you need to know about impound calculations for taxes and insurance, this post will review 1) what an impound account is and 2) how the charges for these accounts are calculated.
What is an Impound Account?
Here’s how the Consumer Financial Protection Bureau (CPFB) explains it:
“An impound account is set up by your mortgage lender to pay certain property-related expenses. The money that goes into the account comes from a portion of your monthly mortgage payment.”
As a side note, when they say, “property-related expenses” they’re generally referring to taxes and insurance. They go on:
“Many lenders require that you pay your taxes and insurances using impound, so they can make sure that the bill gets paid. Your mortgage servicer will manage the account and pay these bills on your behalf.”
What the CPFB doesn’t mention is exactly how an impound account affects your closing costs.
When you close on a home, you will need to fund the impound account so the lender has enough money from you to make the tax installment and insurance payments. Many home buyers are shocked to see how much they must pay to fund their impound account.
To make sure you’re not caught by surprise, we’ll review how impound charges are calculated. For now, we’ll only focus on the tax portion of your impound account. After that, we’ll cover how to calculate the cost of insurance.
How is My Tax Impound Account Calculated on a California Mortgage?
We’ll start by showing you the formula and its inputs, then reviewing why and how each piece of the formula fits. Finally, we’ll run through a few examples to tie it all together.
Your tax impound charge at the time of closing is calculated using the following constants (A & B) and variables (C & D):
A = Total # of Months in the Year (This is always 12)
B = Total # of Months of Reserves (This is always 2)
C = Total # of Months Between 1st Mortgage Payment and 2nd Installment
D = Does Your 1st Mortgage Payment Fall Between December and the 2nd Installment? (Yes/No)
Note: If your answer to D is Yes, then D = 6. If No, then D = 0.
Here’s the formula:
A + B - C - D = Tax Impounds Due at Closing
To understand this formula, you first have to know when tax installment payments are due.
It varies in every state, but we’ll use California as the example. In CA, tax installments are due on the following dates:
- 1st installment covers 7/1 thru 12/31 and is due on 11/1 and delinquent after 12/10
- 2nd installment covers 1/1 thru 6/30 and is due on 2/1 and delinquent after 4/10
Because there are two months before the 2nd installment payment is delinquent, the actual date on which your lender makes the 2nd installment payment may vary, which will affect Variable C. But more on that later.
Keep in mind that your servicer or lender is going to charge you two months more than you actually owe. This is because lenders require two months of padding in your impound account so they know there’s enough money to make your tax payments.
So far, we have two constants in the impound calculation, which are:
- Constant A: 12 months of taxes in a year.
- Constant B: The 2 months of reserves that all lenders require.
Next up are the variables in our calculation.
As mentioned, the date on which your lender makes the payment for the 2nd installment will vary.
This is important because Variable C is the number of months between your 1st mortgage payment and when the lender makes the 2nd installment payment.
Variable C will be subtracted from the total months that you owe at closing because, in the time between your 1st mortgage payment and the 2nd tax installment payment, you’ll be funding your impound account through your ongoing mortgage payments.
So if your 1st mortgage payment date is November 1st and your lender makes the 2nd installment payment in February, Variable C equals 4 months.
Variable D is whether or not the date of your 1st mortgage payment falls between December and the date that your lender pays the 2nd installment.
If your mortgage payment does fall between these dates, that means the 1st installment of taxes has already been paid. So your lender only needs to collect impounds to cover the 2nd installment payment.
That’s why, if your answer to the question posed by Variable D is “Yes”, then you subtract six months worth of taxes from your total bill.
Tax Impound Account Calculation Examples
- 1st payment date is November 1st.
- Lender makes 2nd tax installment payment in Feb
- 2 months of padding
- # of months between 1st payment and 2nd installment payment = 4
- 1st payment does not fall between Dec & Feb
Calculation: 14 – 4 - 0 = 10 months of impounds.
- 1st payment date is Jan 1st.
- Lender makes 2nd tax installment payment in March
- # of months between 1st payment and 2nd installment = 3
- Does 1st payment between Dec & Feb? = Yes
Calculation: 14 – 3 – 6 = 5 months of impounds.
A Note on Refinance Transactions
If you are doing a refinance and you currently have an impound account with your current lender you will get a refund within about 30-45 days. You can check on the amount of the refund by checking your most recent mortgage statement or by giving a quick call to the servicer.
What About Insurance Impounds?
We’ve left out insurance impounds calculations because they’re fairly simple. The full premium is due once a year and your lender or servicer require 2 to 3 months of reserves. So, when you close on a home, your insurance impound calculation is:
- 1 full year of premiums + 2 or 3 months reserves = Total of 14 to 15 months
Alternatively, if you’re closing on a refinance transaction your calculation is:
- (1 full year premiums + 2 or 3 months reserves) - # of months left on the policy
So to calculate your total impound charge, you’ll need to use the formula above for the tax portion, then add on the cost of your insurance impounds.
Hopefully this post helped you understand how to calculate impound fees on your mortgage. If you're still having trouble, click the button below to schedule a free consultation. One of our loan experts will happily answer your questions.