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Escrow 101: Conducting an Escrow Analysis

by Michael J. McCormick
McCalla Raymer – USFN Member (GA)

Introduction
Several recent court decisions have discussed a mortgage servicer’s obligations with regard to escrow accounts after the filing of a bankruptcy. In addition, borrowers and their attorneys often have difficulty understanding the numbers contained in an escrow analysis. Accordingly, this writer felt it beneficial to outline the steps in conducting an escrow analysis, as well as some of the servicer’s obligations under the Real Estate Settlement Procedures Act (RESPA) and options for having a borrower cure a shortage or deficiency. In a subsequent article, I will discuss how a mortgage servicer’s requirements and options, with respect to escrow accounts, are affected by a bankruptcy filing.

RESPA and Regulation X
Section 10 of RESPA1 places limits on the amount a lender or servicer may require a mortgagor to keep in his or her escrow account to cover the payment of taxes, insurance, or other disbursements.2 This section also governs a servicer’s obligations with respect to providing an annual escrow account statement (i.e., escrow analysis)3
and notice “not less than annually” of any shortage in the escrow account.4  

The regulation governing RESPA can be found at 24 CFR § 3500. This regulation is sometimes referred to as Regulation X (herein “the Regulation”). The regulation dealing with escrow accounts can be found at part 3500.17, and the latest escrow account provisions became effective October 1997.

Regulation X defines an escrow account as:

any account that a servicer establishes or controls on behalf of a borrower to pay taxes, insurance premiums (including flood insurance), or other charges with respect to a federally related mortgage loan, including charges that the borrower and servicer have voluntarily agreed that the servicer should collect and pay. The definition encompasses any account established for this purpose, including a “trust account,” “reserve account,” “impound account,” or other term in different localities. An “escrow account” includes any arrangement where the servicer adds a portion of the borrower’s payments to principal and subsequently deducts from principal the disbursements for escrow account items. For purposes of this section, the term “escrow account” excludes any account that is under the borrower’s total control.

Initial and Annual Escrow Statements

Initial Statement
A servicer that establishes an escrow account in connection with a “federally related mortgage”5 must provide the borrower a statement that clearly itemizes the estimated taxes, insurance premiums, and other charges that are reasonably anticipated to be paid from the escrow account during the first 12 months after the escrow account is created. This statement must be provided to the borrower either at closing, or within 45 days after creation of the escrow account. If the initial statement is provided to the borrower at closing of the loan, the servicer may incorporate such statement in the uniform settlement statement.6

Annual Statement
A servicer that has established or continued an escrow account must provide the borrower with a statement at least once for each 12-month period (otherwise known as the “escrow account computation year”)7 during which the servicer maintains the escrow account that “clearly” itemizes:

i)     the amount of the borrower’s current monthly payment;
ii)    the portion of the monthly payment being placed in the escrow account;
iii)   the total amount paid into the escrow account during the period;
iv)    the total amount paid out of the escrow account during the period for taxes, insurance premiums, and other charges (as separately identified);
v)     the balance in the escrow account at the conclusion of the period;
vi)    an explanation of how any surplus is being handled by the servicer;
vii)   an explanation of how any shortage or deficiency is to be paid by the borrower; and
viii)  if applicable, the reason(s) why the estimated low monthly balance was not reached, as indicated by noting differences between the most recent account history and last year’s projection.8

The Regulation allows the servicer to provide or deliver the annual escrow statement to the borrower along with other statements or materials, including Form 1098, which is provided for federal income tax purposes.9

If at the time the servicer conducts the escrow account analysis the borrower is more than 30 days overdue, then the servicer is exempt from the requirements of providing an annual escrow account statement to the borrower under Section (i) of the Regulation. This exemption also applies where the servicer has brought an action for foreclosure under the underlying mortgage loan, or where the borrower is in a bankruptcy case. However, if the servicer does not issue an annual statement pursuant to this exemption and the loan subsequently is reinstated or otherwise becomes current, the servicer must provide a history of the account since the last annual statement (which may be longer than 12 months) within 90 days of the date the account became current.10 It is important to note that even if the servicer chooses not to provide a borrower with a copy of an escrow analysis under this exemption, the servicer nevertheless still has an obligation to perform the escrow analysis on an annual basis. Moreover, as is emphasized later in this article, this exemption is independent from the servicer’s obligation to provide the borrower with notice of any shortage or deficiency in the escrow account on at least an annual basis.11

Short-year statements
A servicer may issue a short-year annual escrow account statement (“short-year statement”) to change one escrow account computation year to another. By using a short-year statement, a servicer may adjust its schedule for its entire portfolio or alter the escrow account computation year for the escrow account. The short-year statement has the effect of ending the “escrow account computation year” for the escrow account and establishing the beginning date of the new escrow account computation year. Therefore, the servicer must deliver the short-year statement to the borrower within 60 days from the end of the short year. 

If a borrower pays off a mortgage during the escrow account computation year, the servicer is required to send a short-year statement to the borrower within 60 days after receiving the payoff funds.

Transfer of Servicing
If servicing of the loan is transferred and the new servicer changes either the monthly payment amount or the accounting method used by the transferor (i.e, old servicer), then the new servicer must provide the borrower with an initial escrow account statement within 60 days of the date of servicing transfer. If the new servicer provides an initial escrow account statement upon the transfer of servicing, the new servicer must use the effective date of the transfer of servicing to establish the new escrow account computation year. On the other hand, where the new servicer retains the monthly payments and accounting method used by the old servicer, the new servicer may continue to use the escrow account computation year established by the old servicer or may choose to establish a different computation year using a short-year statement. At the completion of the escrow account computation year or any short year, the new servicer must perform an escrow analysis and provide the borrower with an annual escrow account statement.13 Regardless of whether the new servicer changes or retains the payment amount of accounting method used by the old servicer, upon the transfer of servicing, the transferor (i.e., old servicer) must provide a short year statement to the borrower within 60 days of the effective date of the transfer of servicing.14

Penalties and Remedies
Section 10(d) of RESPA provides that for each failure to provide a borrower with an escrow statement, the Secretary of HUD “shall” assess the lender or escrow servicer a civil penalty of $50. However, the total amount that may be imposed on a lender or escrow servicer during any 12-month period is limited to $100,000.15 But if any failure to provide the escrow statement is “due to intentional disregard of the requirement” to provide the escrow statement, then the penalty for each failure is $100. Moreover, the $100,000 limit does not apply.

It is important to note that while other sections of RESPA provide a borrower with a private remedy (e.g., where a servicer fails to respond to a qualified written request), a borrower does not have a private remedy against a servicer under Section 10 of RESPA for failing to provide an escrow statement as required.16

The Escrow Analysis
For purposes of Regulation X, an escrow analysis is the accounting that a servicer conducts in the form of a trial running balance for an escrow account to:

i)      Determine the appropriate target balances;
ii)     Compute the borrower’s monthly payments for the next escrow account computation year and any deposits needed to establish or maintain the account; and
iii)    Determine whether shortages, surpluses, or deficiencies exist.

In general, there are five steps in completing an escrow analysis, which are delineated in Section (d) of the Regulation. This new accounting method requires borrowers to maintain a lesser amount in their escrow accounts than the “single-item” method used by lenders. According to HUD’s website, however, the new accounting method has resulted in many lenders increasing the size of the escrow account cushion to the maximum allowed.

Several examples of the steps in conducting an escrow analysis appear in Appendix E to the Regulation.17 However, an easier and more straightforward example appears on HUD’s website.18 To simplify the explanation below, I will use the same numbers contained in the example on HUD’s website.

Step 1 - Anticipated Escrow Disbursements
The first step in the analysis is to list all of the anticipated disbursements that will be paid out of the escrow account over the next 12 months. The example assumes $1,200 for property taxes ($500 paid July 25 and $700 paid December 10) and $360 for hazard insurance on September 20.

             County Taxes                                        $1,200.00
             Homeowner’s Insurance                        $   360.00
             Total                                                     $1,560.00

If the borrower has a payment for flood insurance, which is ordinarily paid every three years, the Regulation requires the servicer to project a trial balance over the three-year period.19

Section (c)(3) of the Regulation says, “[i]n conducting the escrow account analysis, the servicer must estimate the disbursement amounts according to paragraph (c)(7) of this section.” Section (c)(7) says the servicer shall estimate the amount of escrow account items to be disbursed. If the servicer knows the charge for an escrow account item20 in the next computation year, then the servicer shall use that amount in estimating disbursement amounts. But if the charge is unknown to the servicer, the servicer may base the estimate on the preceding year’s charge, or the preceding year’s charge as modified by an amount not exceeding the most recent year’s change in the national Consumer Price Index for all urban consumers (CPI, all items). [emphasis added] In estimating the amount to be disbursed, a servicer should be mindful that unless a borrower’s payments are not more than 30 days overdue, the servicer must pay the escrow items in a timely manner to avoid a penalty.

Step 2 - Calculating the Monthly Escrow Component
The second step in the analysis calls for the servicer to divide the total from Step 1 by 12 monthly payments ($1,560 divided by 12 = $130).

Step 3
The third step in the escrow analysis requires the servicer to create a trial running balance for the next 12 months, listing all payments into the escrow account and all payments out of the account, and when the anticipated disbursements above are expected to be paid.

This of course leads one to ask, what is the servicer required to assume about payments coming into the escrow account between the time the escrow analysis is performed and the effective date of the analysis, which is usually a month or two later? Some borrowers (and their attorneys) believe that a servicer is required to assume the payments for the last few months of the escrow computation period, that is, leading up to the effective date of the new analysis, will come into the escrow account. In fact, Section (i)(l) of the Regulation says that in preparing the statement, the servicer may assume scheduled payments and disbursements will be made for the final two months of the escrow account computation year.21 To emphasize, the operative word is “may.” This is important for projecting the initial balance in the escrow account on the effective date.

Step 4
Step 4 requires the servicer to increase all of the monthly balances to bring the lowest point in the account (in the HUD example, December -$780) up to zero. This is sometimes referred to as the theoretical low point. Usually the low point comes in the month where the property taxes have been paid.22 

  Payment  Disbursement   "Step 3" Balance  "Step 4" Balance

 June

 -

 0

  780 

 July

 130

500 

 -370

  410 

 Aug

 130

 0

 -240

 540

 Sept.

 130

 360

 -470

 310

 Oct.

 130

 0

 -340

 440

 Nov.

 130

 0

 -210

 570

 Dec.

 130

 700

 *-780

 *0

 Jan.

 130

 0

 -650

 130

 Feb.

 130

 0

 -520

 260

 March

 130

 0

 -390

 390

 April

 130

 0

 -260

 520

 May

 130

 0

 -130

 650

 June

 130

 0

 0

 780

 

 

 

 

 



 

 

Step 5
Step 5 directs the servicer to add any cushion the lender requires to the monthly balances. The cushion may be a maximum of one-sixth of the total escrow charges anticipated over the next 12 months.23 The Regulation provides that the servicer shall examine the loan documents to determine the applicable cushion and limitations for each escrow account. If the loan documents provide for lower cushion limits than under the Regulation, then the terms of the loan documents apply. Where the terms of any loan document allow greater payments to an escrow account than allowed by the Regulation, then the Regulation controls the applicable limits. Where the loan documents do not specifically establish an escrow account, whether a servicer may establish an escrow account for the loan is determined by state law. If the loan document is silent on the escrow account limits and a servicer establishes an escrow account under state law, then the limitations under the Regulation apply, unless state law provides for a lower amount. If the loan documents provide for escrow accounts up to the RESPA limits, then the servicer may require the maximum amounts consistent with the Regulation, unless an applicable state law sets a lower amount.24

In the example provided: 1/6 of $1,560 = $260.00

  Payment  Disbursement   Balance

 June

 -

  1040

 July

 130

 500 

  670 

 Aug

 130

 0

 800

 Sept.

 130

 360

 570

 Oct.

 130

 0

 700

 Nov.

 130

 0

 830

 Dec.

 130

 700

*260

 Jan.

 130

 0

 390

 Feb.

 130

 0

 520

 March

 130

 0

 650

 April

 130

*0

 780

 May

 130

 0

 910

 June

 130

 0

 1040

 

 

 

 

 

 

 

 

    * HUD’s example shows a disbursement of $300 in April, which appears to be an error.
So following the RESPA/HUD guidelines, the maximum the servicer could require in the escrow account is $1,040.

Surpluses, Shortages, and Deficiencies
At this point, the servicer then compares the “required” amount (otherwise known as the “target balance”) to the actual account at the time the escrow analysis was being performed (in the example provided, the escrow analysis is being performed in the month of June).25 If the amount in the escrow account exceeds the required amount, then there is a “surplus” in the escrow account. Where the surplus is less than $50, the servicer may apply the surplus to reduce the amount of the escrow payment, or may choose to return the surplus to the borrower. If the surplus is more than $50, the servicer must return the surplus to the borrower within 30 days of performing the escrow analysis.

It is important to note that these provisions regarding surpluses only apply if the borrower is current at the time of the escrow account analysis. According to the Regulation, a borrower is considered to be current if the servicer receives the borrower’s payments within 30 days of the payment due date. However, if the servicer does not receive the borrower’s payment within 30 days of the payment due date, then the servicer may retain the surplus in the escrow account pursuant to the terms of the loan documents.

If the amount in the escrow account is positive, but less than the required amount, then there is an escrow shortage.26 If the amount of the escrow shortage is less than one month’s escrow payment, the servicer may ask the borrower to pay this shortage within 30 days, or the servicer may spread it out over 12 months. If the amount of the escrow shortage is greater than one month’s escrow payment, then the servicer must spread the shortage out over at least 12 months. A servicer may also do nothing and allow an escrow shortage to exist.27

If the amount in the escrow account not only falls below the required amount but is negative (i.e., where the servicer has had to use its own funds to make a disbursement), then there is an escrow deficiency.28 As with an escrow shortage, if the amount of the deficiency is less than one monthly escrow payment, the servicer may require the borrower to pay the deficiency within 30 days. However, if the amount of the deficiency is equal to or greater than one monthly escrow payment, the servicer may require the borrower to repay the amount over 2-12 months. A servicer also has the option to allow the deficiency to exist and do nothing to change it.29 

It is again important to note that these provisions regarding deficiencies apply only if the borrower is current at the time the servicer is performing the escrow account analysis. A borrower is considered to be current under the Regulation if the servicer receives the borrower’s payments within 30 days of the payment due date. However, if the servicer does not receive the borrower’s payment within 30 days of the payment due date, then the servicer may recover the deficiency pursuant to the terms of the loan documents.30

Regulation X also contains additional requirements with regard to escrow shortages or escrow deficiencies. To begin with, Section (f)(5) requires the servicer to provide the borrower with notice of any shortage or deficiency in the escrow account on at least an annual basis.31 Since this requirement appears in a different section of the Regulation other than the requirement to provide the borrower with an annual escrow statement, the two requirements are independent of each other. Therefore, any exception or exemption from having to provide an annual escrow statement, such as where the loan is delinquent or the borrower is in a bankruptcy case, does not excuse the servicer from having to provide notice of an escrow shortage or deficiency on at least an annual basis.32 Moreover, the Regulation also provides that if a servicer advances funds for a borrower, then the servicer must perform an escrow account analysis before seeking repayment of the deficiency. Arguably, the phrase “seeking repayment of the deficiency” could include seeking repayment of the deficiency through a bankruptcy case by way of a proof of claim.

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