Tax Guru – Ker$tetter Letter

For decades I have been warning people about the dangers of relying on lenders to handle their property tax and insurance payments via impound accounts. Many people have the false impression that using a lender impound account is more convenient than having to pay these bills themselves.  I have seen far too many cases where lenders have missed payments on both property taxes and insurance.  This is even more likely to occur when a loan is sold to a different lender than you started with, or lenders merge, which happen with almost all loans.

Besides the risk of losing one’s house for unpaid property taxes, as in this recent case, there are other pitfalls to depending on lenders.  I have frequently had to be the bearer of bad news and explain to clients that they can’t deduct payments to their lenders’ impound accounts if the property taxes weren’t actually paid to the County.  Under IRS rules, the lender is considered to be an agent of the taxpayer, and if they are still holding onto that money as of December 31, it’s the same as if nothing was paid for the taxes.

In a similar vein, even with lenders who pay the property taxes, they normally make those payments at the latest possible date. This removes a very common tax planning technique, which is to make the next year’s property tax payment in December of the year before in order to get the tax benefit a year earlier.  With no impound account, you have the freedom to do this.  With an impound account, you are SOL and the lender will laugh in your face if you request an early payment of the taxes.

An even more extreme danger is the nonpayment of homeowner’s insurance.  I have seen cases where homes have burned to the ground and then the homeowners discovered that their insurance coverage had lapsed because the lenders hadn’t sent in the premium payments, even though all of the loan payments had been made on time.

I am fully ware that in some cases, such as with a low down payment (usually less than 20%), lender impound accounts are mandatory in order to obtain the loan. However, in cases where it is optional, borrowers should definitely opt out of the impound account and pay their own taxes and insurance.  What many borrowers don’t know is that, for cases where a loan began with a mandatory impound account, that can be changed after a few years, as the borrower’s equity grows to over the 20% level.  This will sometimes require an appraisal or Realtor CMA to verify; but is well worth it to get away from the risky situation of having lenders in control of your fate with taxes and insurance.