Legal Definitions - reserve account

A reserve account, often referred to as an impound account, is a special type of savings account established and managed by a lender on behalf of a borrower. Its primary purpose is to collect and hold funds from the borrower's regular payments to cover anticipated, recurring property-related expenses, such as property taxes and homeowner's insurance premiums. By collecting these funds incrementally with each loan payment, the lender ensures that sufficient money is available to pay these critical expenses when they become due, thereby protecting the lender's financial interest in the property.

• Example 1 (Residential Mortgage): When Maya purchased her first home, her monthly mortgage payment included an extra amount in addition to the principal and interest. This additional sum was deposited by her lender into a reserve account. Each year, when her property taxes and homeowner's insurance premiums were due, the lender used the accumulated funds from this reserve account to pay these bills directly on her behalf.

  Illustration: This demonstrates a reserve account because the lender is collecting extra funds from Maya's monthly payment and holding them in a separate account specifically to cover future, predictable property expenses (taxes and insurance), ensuring these crucial payments are made on time and protecting the lender's security interest in the home.

• Example 2 (Commercial Property Loan): A small business owner, Mr. Kim, took out a loan to purchase a commercial building for his expanding bakery. As part of the loan agreement, his bank required him to contribute a portion of his monthly payment into a reserve account. This account accumulated funds throughout the year, which the bank then used to pay the annual property taxes and the building's commercial insurance policy premiums when they were due.

  Illustration: Here, the reserve account serves the same function as in a residential mortgage, but in a commercial context. The bank manages the account to ensure that the property's essential expenses (taxes and insurance) are covered, protecting its investment in the commercial real estate and ensuring the property remains insured and tax-compliant.

• Example 3 (High Loan-to-Value Mortgage): Sarah obtained a mortgage with a relatively small down payment, resulting in a high loan-to-value (LTV) ratio. Due to the increased risk associated with a higher LTV, her lender mandated the establishment of a reserve account. Even though Sarah might have preferred to pay her property taxes and insurance directly, the lender required her to include these amounts in her monthly mortgage payment, which were then held in the reserve account and disbursed by the lender when the bills were due.

  Illustration: This example highlights how a reserve account can be a mandatory condition of a loan, especially when the lender perceives a higher risk. It clearly shows the lender's role in managing funds specifically set aside from regular payments to cover future property expenses, thereby mitigating risk and safeguarding their interest in the property.