How Much are Property Taxes and Insurance? Why are We Paying that Now?

When buying a home people pay a lot of attention to the principal and interest (P&I) payments. This makes sense as it’s the largest chunk of the monthly payment. But you shouldn’t forget about the tax and insurance (T&I) payments that round out a monthly mortgage payment and how these payments can affect closing costs.

OK nobody really forgets about taxes and insurance it’s more that people underestimate how much they can affect closing costs and how those costs can change based on the closing date.

This is often a point of concern when purchasing a home because the payment of taxes and insurance could lead to a credit or cost to the buyer at the close of escrow (it’s almost always a cost). These credits or costs could be hundreds or thousands of dollars and it can be confusing to figure out how the exact dollar amounts are calculated and why that amount varies depending on when you close on the purchase.

It’s not unusual to have a buyer ask “How much do we owe in taxes and insurance? And why are we paying that now?”

Unless you’re one of the people who has chosen to pay your taxes and insurance in lump sum payments at the appointed deadlines you will have an impound account created. The purpose of the impound account is to collect a portion of your tax and insurance payment every month as part of your monthly mortgage payment. You’ll pay every month into the account then when the bill comes due it gets paid out of the account.

Tax and insurance payments are generally thought of as annual premiums or payments but when you’re selling or buying a home these costs are calculated at a monthly or sometimes even a daily rate. This is because the seller and buyer will only be responsible for the taxes and insurance for the days they each owned the property.

These costs will be estimated by the Broker for the Loan Estimate with the final calculations being done by the loan funder during doc prep.

Taxes

In Maricopa County AZ. taxes are due in March and October. Maricopa County collects taxes in arrears, meaning that the property tax bill due in March 2017 is for the second half of 2016, July through December. The property tax bill due in October of 2017 is for the first half of 2017, January through June.

Consider a house closing on April 30th with a first mortgage payment of June 1st and a total annual property tax bill of $2,835.12. The property will have two tax payments of $1,417.56, one due in October and one due in March ($2,835.12 / 2 = $1,417.56).

In this example, the seller would have paid taxes in March for the time period July 1st – December 31st of the prior year. The seller is also responsible for paying the taxes for January 1st through April 30th of the current year.

To estimate the total amount the seller is responsible for:

1. Divide the total October tax payment by the number of months covered to get a monthly payment ($1,417.56 / 6 = $236.26).
2. Multiply the number of months the seller is responsible for by monthly payment to get the total tax burden  (4 x $236.26 = $945.04).

The estimated seller responsibility would be $945.04 in property taxes which will be credited to the buyer at close of escrow (COE). This credit, or payment, will cover the seller’s tax obligation.

At COE the buyer will become responsible for making the entire half year tax payment for January 1st – June 30th and they will have to deposit at least a portion of that payment at close to ensure there is enough in the account to make the tax payment in October.

One way to estimate how much tax goes into the initial impound account is to work backward from the October payment date. At that point, the buyer would want to have a ½ year of taxes to cover the bill + 2 months “cushion” to cover any unanticipated tax changes.

Why 2 months?

The Real Estate Settlement Procedures Act (RESPA) allows but does not require lenders to set up an impound account for tax and insurance payments to secure the investment. But RESPA does limit the amount of “cushion” that can be collected and impounded to 1/6th or 2 months.

With an initial mortgage payment of June 1st, there will be 4 mortgage payments before the October tax bill is due (June, July, August, & September). So at the close of escrow, the buyer will want to deposit 4 months worth of taxes into the impound account. This would mean the impound account should have a full balance to pay the tax payment in October (½ year) as well as a 2-month cushion.

To estimate the total amount the buyer is responsible for:

1. Divide the total October tax payment by the number of months covered to get a monthly payment ($1,417.56 / 6 = $236.26).
2. Multiply the number of months the buyer will be impounding by monthly payment to get the total amount  (4 x $236.26 = $945.04).

The buyer should be prepared to deposit $945.04 into their impound account at the close of escrow.

Insurance

The lender may also want the buyer to impound payments for homeowners insurance.

Homeowners insurance would be handled similarly to the tax payment. Here’s an example for a property with an annual homeowner’s insurance premium of $1528.55.

1. Divide the annual premium by the number of months covered to get a monthly payment ($1528.55 / 12 = $127.38).
2. Multiply the number of months the buyer will be impounding by the monthly payment  (2 x $127.38 = $254.76).

The buyer should be prepared to deposit $254.76 into their impound account at the close of escrow to cover homeowners insurance.

Keep in mind these are estimates calculated to protect the buyer from depositing too little money. During final document preparation, the full payments will be calculated by the loan funder and this number will be adjusted to reflect the actual cost. This is often called the aggregate accounting adjustment.

For more light reading on the aggregate accounting adjustment and other fun features of RESPA, you can continue below or click here.

From – http://finance.zacks.com/mortgage-aggregate-adjustment-10845.html. Mortgage Aggregate Adjustment – The mortgage aggregate adjustment determines the initial deposit that must be placed in the escrow account at closing. The formula is used to calculate the amount that allows a two-month cushion, which is a maximum sum of money in addition to the amount needed to cover escrow items in the borrower’s account at all times. It provides the lender with enough funds to pay for such items as property taxes and insurance. However, the escrow amount should not exceed what is legally allowed by Section 10 of the Real Estate Settlement Procedures Act. RESPA Limits – Lenders are allowed, but not required, by federal law to require borrowers to pay into an escrow account. Nevertheless, a lender may establish an escrow account to secure the investment in the collateral, and ensure the account covers any adjustments in escrow payments. The cushion for the escrow account should not exceed one-sixth of the aggregate amount of money for escrow payments. State laws, however, may require a lesser amount for the escrow cushion, which defeats RESPA limits, and the lender must follow the state law escrow limits. Escrow Calculation – To determine the initial escrow deposit amount, the lender starts with calculating the lowest projected balance for the account after the expected monthly escrow payments are paid for the year, which is the aggregate accounting adjustment. After the lowest negative balance is determined, the lender would add the cushion, which is calculated to be two monthly payments or less, depending on state laws. Accounting Adjustment – On the HUD-1 Settlement Statement, section 1000 is the “Reserves Deposited with Lender.” If the lender establishes an escrow account, this section will include the initial deposit for the escrow account and the items that will be paid out of the escrow account. Once the initial deposit amount is determined, the lender will include the aggregate adjustment on the last line in this section. This amount will be a credit to the borrower, and is either zero or a negative number. Annual Review – Each year, the lender must review each escrow account to ensure that the total funds in the borrower’s account reflects an accurate amount to pay for escrow items, and the amount should be within the limits required by RESPA. If there are any shortages in the account, the lender can make adjustments for future escrow payments to replace the shortage. If there are any overages, the borrower may request a refund of the amount of the overage.

For more information contact Aaron Walker or Jay Rapson at Aaron Lending, LLC.