Under what condition may a lender require a borrower to use a trust account for payment of taxes and property insurance?

A lender may require a borrower to use a trust account for the payment of taxes and property insurance when the loan amount is at a loan-to-value (LTV) ratio of 90% or greater. This requirement is rooted in risk management practices. Lenders impose this condition primarily because a higher LTV indicates that the borrower has less equity in the property, increasing the lender's risk exposure. By requiring a trust account, lenders ensure that funds for property taxes and insurance premiums are set aside and managed, thereby reducing the risk of the borrower defaulting on these obligations. This protective measure safeguards the property and the lender's investment, ensuring that property taxes are paid on time and insurance coverage is maintained, mitigating potential liabilities or losses that might arise if these obligations were neglected.

Understanding the importance of equity in the context of borrower risk helps clarify why LTV ratios are critical in lending policies. For instance, if the LTV is lower than 90%, it generally indicates that the borrower has more equity in the property, which may lower the perceived risk for the lender and could result in more lenient requirements concerning the use of a trust account.