A crucial step when creating a mortgage note is deciding whether the borrower or lender will
assume responsibility for paying property taxes and insurance premiums. Establishing an escrow
(impound) account for a loan offers the advantage of monitoring tax and insurance payments as
the lender holds the money in trust for the borrower’s benefit.
Borrower and Lender Responsibilities
If the borrower is managing taxes and insurance, it is vital for the lender to make sure that the
borrower meets all required payments. Regular communication with tax authorities and the
insurance company to verify paid taxes and active insurance coverage will avoid future
difficulties.
Property Taxes
It is imperative that the borrower makes the annual property tax payments on time, and the
lender is vigilant in checking. Not doing so may subject the property to a tax sale, resulting in the
loss of the lender’s interest in the property.
The taxing authority does not typically send the mortgage holder a yearly separate tax bill;
instead, they usually send it directly to the borrower. Also, the authority may not notify the
lender of an impending tax sale and its redemption period if one exists. For this reason, a tax
escrow can help avoid the issue of tax foreclosure.
Property Insurance
An insurance lapse without the knowledge of the lender could result in significant problems,
especially if a natural disaster or fire damages the property during that time.
It is essential to confirm that the property insurance adequately covers the mortgage note if there
is a total property loss. In certain situations, obtaining sufficient coverage may be challenging for
the borrower, and negotiation may be necessary to adjust the coverage amount based on the
property’s land value.
For example: You sell a mobile home and ten acres of land and provide seller financing with a
mortgage note of $75,000.00. The borrower, however, can only obtain insurance for the mobile
home for $55,000.00. As the lender, you must decide if the land value is sufficient to cover the
$20,000.00 gap that the insurance company will not cover. While this scenario is not the norm, it
does happen on occasion.
Escrow Account Advantages
A tax and insurance escrow account for a loan provides peace of mind for both borrower and
lender. The borrower’s funds are held in trust in a separate account by the lender to ensure that
property taxes and insurance premiums are paid on time, relieving stress and worry. The lender
must provide a precise accounting yearly and adjust the escrow payments, as necessary.
The lender does not spend needless time making multiple calls throughout the year to confirm
that the borrower pays property taxes and insurance payments on a prompt basis.
Maintaining a two-month reserve payment in the monitored escrow account is advisable, serving
as a cushion if amounts increase during the year.
For instance, if you create a mortgage note with a property tax of $752.80, then divide that
amount by twelve to find the monthly tax escrow payment, equaling $62.74. The cushion
payment for a two-month reserve would then be $125.48.
You would use the same approach to calculate the insurance. If the premium is $1,200.00
annually, the monthly payment would be $100.00, plus an added $100.00 if using a cushion.
This would result in a total monthly escrow payment for property tax and insurance of $162.74
or $325.48 for a cushion, in addition to the monthly principal and interest payment.
Once set up, an escrow account can manage property taxes and insurance together or separately.
Combining them is easy, convenient, and hassle-free.
Conclusion
An escrow (impound) account for a mortgage note guarantees on time payments for property
taxes and insurance coverage. This protects both the borrower and lender from constant worry as
the account fulfills payment obligations.
For further questions on an escrow account or selling a mortgage note, please contact Steve or
Ryan at American Equity Funding.
American Equity Funding
1-800-874-2389