Does VA Require Impounds?

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The Department of Veterans Affairs (VA) home loan program provides many benefits to eligible veterans, active-duty service members, and qualifying surviving spouses. One key question borrowers may have when applying for a VA loan is whether an impound account is required.

What is an Impound Account?

Also known as an escrow account, an impound account is a special account held by the lender to pay certain homeownership expenses on the borrower’s behalf. With an impound account, the borrower pays a portion of their mortgage payment each month into the account, and the lender uses those funds to pay expenses such as:

  • Property taxes – Impound accounts ensure property taxes are paid on time, preventing penalties and tax liens.
  • Homeowners insurance – Impounds cover yearly home insurance premiums, maintaining adequate coverage.
  • Mortgage insurance – Impounds can pay monthly mortgage insurance premiums.
  • HOA fees – For properties in homeowner associations, HOA fees are often paid via impound.

Funds are set aside each month so that when these bills come due annually or at other intervals, the money is ready to distribute for payment.

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Does the VA Require Impound Accounts?

The short answer is no, the VA does not require impound accounts as part of their basic loan program guidelines. The decision on whether or not to require an impound account is left up to individual lenders.

According to the VA lender handbook [1]:

“VA regulations do not require collection of monthly escrows for insurance and taxes. However, loan holders may establish escrow accounts at closing for the purpose of allocating payments by the borrower to insurance and taxing authorities to ensure these payments are made on a timely basis.”

So while the VA gives lenders the option to require impounds if they choose, it is not mandatory across all VA loans. Some VA lenders require impound accounts as part of their policies, while others make them optional.

Why Doesn’t the VA Require Impound Accounts?

The VA likely leaves this decision in the lenders’ hands for a few reasons:

  • Flexibility – Giving lenders discretion allows them to set policies appropriate for their target markets and borrower profiles.
  • Borrower benefits – Not requiring impounds reduces upfront cash needed at closing and monthly payments. This aids affordability.
  • Lower risk – For higher risk loans or borrowers with past payment issues, impounds help ensure taxes and insurance are paid. But for lower risk borrowers, lenders may waive impounds if permitted.

So in keeping with their mission of helping veterans and service members become homeowners, the VA creates flexibility around impounds based on individual borrower and property circumstances.

When Do Lenders Require Impound Accounts?

Lender policies on impounds vary. While requirements differ, here are some common scenarios where a lender may require an impound account for a VA loan:

High-Risk Borrowers

For borrowers with past credit events like bankruptcy, foreclosure, or major delinquencies, lenders view requiring an impound account as an extra safeguard. Impounds reduce risk of future missed tax and insurance payments that could endanger the collateral.

Low Credit Score Borrowers

Borrowers with credit scores below 620 are often required to have an impound account. Again this comes down to mitigating risk based on the borrower’s demonstrated willingness and ability to make timely payments.

High Loan-to-Value (LTV) Loans

The higher the LTV ratio (the more owed compared to the property value), the higher the risk. So lenders frequently require impounds on VA loans with LTVs at or above 90%.

Investment/Rental Properties

Lenders see investment properties as higher risk than primary residences. They are also aware landlords sometimes struggle to pay taxes and insurance without steady rental income. Impounds are common requirements for VA loans on non-owner-occupied properties.

Specific States

Some states have higher delinquency rates for property taxes and insurance payments. Lenders may automatically require impounds on properties in those states, regardless of other factors. Examples include Florida, New Jersey, Maryland, and Illinois.

Borrower Preference

Occasionally borrowers elect to have an impound account, even if not required by the lender. This guarantees funds are set aside for taxes and insurance, avoiding the burden of budgeting for lump sum payments.

So in summary, while impounds are not across the board requirements, VA lenders use them in cases where risk factors make them prudent.

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Pros and Cons of Impound Accounts

Impound accounts have both advantages and disadvantages for borrowers to weigh.

Potential Benefits

  • Ensures taxes and insurance are paid on time
  • Avoids lump sum outlays for annual/periodic bills
  • May get better mortgage rate with impounds required
  • No need to budget/save separately for tax and insurance bills
  • Reduces risk of penalties for late payments
  • Lender tracks payments and maintains documentation

Potential Drawbacks

  • Higher upfront funds required at closing
  • Increased monthly mortgage payment
  • Interest not earned on impound balance
  • Processing delays if lender doesn’t distribute payments promptly
  • Requires cushion that increases monthly amount
  • Extra work if bank doesn’t automatically pay bills from impound as expected

Overall, impounds make sense for borrowers wanting convenience and those with cash flow concerns. But for disciplined budgeters, the flexibility of no impounds may be preferable.

Tips for Getting a VA Loan Without Impounds

If you want to avoid paying into an impound account, here are some tips:

  • Shop lenders – Compare several lenders’ policies to find options without mandatory impounds.
  • Ask for an exception – If the lender normally requires impounds, provide evidence of strong payment history and ask them to waive the requirement.
  • Pay down the LTV – Putting down a larger down payment to get below an 80% LTV threshold can avoid automatic impound requirements.
  • Raise your credit score – Improving your credit score above 620 improves chances of qualifying for a loan without impounds.
  • Close before taxes due – If closing near annual tax deadlines, ask to pay taxes separately at closing and waive the impound.
  • Offer upfront reserves – Providing extra funds in reserves can offset concerns over future payments.
  • Purchase owner-occupied property – Lenders are more flexible on impound requirements for primary residences.

With a little loan shopping, negotiation, and strategic planning, you may be able to land a VA loan without an impound account.

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The Bottom Line

The bottom line is the VA does not mandate impound accounts, but individual lenders may require them based on their own policies and analysis of risk factors. Impounds provide convenience and payment protections, but also increase upfront and monthly costs for borrowers. Veterans and service members should understand lender policies during the loan shopping process to ensure the terms match their needs and preferences. Whileclosing a VA loan without impounds may require effort, it is possible in many cases.

References

[1] VA Lender’s Handbook – VA Pamphlet 26-7, Revised. Department of Veterans Affairs. https://www.benefits.va.gov/warms/pam26_7.asp

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Meghan

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