Impound Accounts : Convenience or Curse? : Borrowers Are Forced to Save While Lender Gets the Interest

When David Brown got a notice from his lender last fall stating that the impound accounts he had set up to pay for taxes and insurance on his Laguna Niguel home were $887 short, he knew that “something wasn’t right.”

According to Brown’s calculations, the $400 he paid into his impound accounts each month would easily cover the two installments on his annual $2,806 property-tax bill and $1,100 insurance premiums when they eventually came due.

In fact, Brown figured his lender would be sending him a check at the end of the year to offset what appeared to be a substantial overage in his account.

But no: By using a controversial accounting technique known as “single-item analysis,” Brown’s lender had determined that he needed to pump nearly $900 extra into the accounts “to ensure sufficient funds are available to pay . . . taxes and/or insurance premiums as they become due.”

“It just didn’t make sense,” said Brown, who himself is chief financial officer for a Tustin-based bank. “The math is pretty simple: $400 a month times 12 months is $4,800, and my annual bills were under $4,000.”

Brown called his lender for an explanation of the proposed $887 surcharge. An analyst for the lender, First Nationwide Bank, explained that the bank required borrowers to have enough cash set aside to pay taxes and insurance bills one month before they actually come due.

And even though this policy essentially forced borrowers to keep more money in their impound accounts than was really needed, the analyst explained, Brown was actually lucky:

Under federal law, First Nationwide could require him to keep the equivalent of two months of escrow funds set aside in case a bill came due but there wasn’t enough cash in the account to pay it.

When Brown still balked at paying the surcharge, he said, First Nationwide threatened him with foreclosure.

Undaunted, Brown began sending his monthly payments directly to the office of First Nationwide’s chairman, along with a monthly note explaining that he still thought he was being overcharged.

Partial Victory

But when the chairman’s office notified Brown that it would no longer accept his payments and renewed its threat to foreclose, Brown settled for a partial victory: Although he didn’t get a rebate check for the amount that he felt had been unlawfully impounded in 1991, the company agreed to reduce his impound charges for 1992.

“I wanted to keep fighting, but it just got to the point where this whole thing was taking up too much of my time,” Brown said.

“This impound-account business is really a racket--lenders get to use your money all year and all they have to pay you is 2%,” Brown complained. “And if that’s not bad enough, the government says its OK for them to overcharge you.”

About 16 million home loans, or 40% of the 40 million mortgages outstanding today, involve the use of impound accounts.

When an impound account is used, the lender essentially takes a piece of the borrowers’ monthly payment and sets it aside to pay property taxes, insurance premiums and other bills when they eventually come due.

Many lenders require their customers to set up impound accounts--sometimes called “escrow” accounts--if the borrower makes a down payment that’s less than 20% of the purchase price of the home.

Because borrowers who make small down payments have relatively high monthly payments that can make saving difficult, the accounts help to ensure that the homeowner will have enough cash set aside to pay big bills when they come due.

Impound accounts “are sort of like a savings plan,” said Carrie Hawkins, an executive with Trinity Mortgage in Arcadia and the president of the California Mortgage Bankers Assn.

“The borrower puts away a little bit of money each month so he won’t have to scramble to pay his insurance or property taxes later.”

But while lenders like to promote impound accounts as a convenience for their customers, the way that the accounts are treated has become a major source of consumer complaints and even government-led lawsuits.

Excess Impound Cash

Many homeowners, such as David Brown, complain that their lender or the “servicing” company that processes their monthly payments requires them to keep too much money in their impound accounts.

Since the accounts earn little or no interest, these borrowers say that they’re being robbed of the money they could make by taking the excess impound cash and investing it in stocks, bonds or interest-bearing savings accounts or money funds.

Other homeowners complain that their impound accounts were mishandled by their lender, or by the “loan-servicing” company that processes their monthly payments.

Some borrowers have been left without insurance protection because their lender forgot to pay their premiums.

Others have been stuck with useless “double coverage” because their lender purchased a policy on their behalf after mistakenly concluding that the borrower had no protection.

A handful of homeowners have even been threatened with foreclosure by government authorities because their lender failed to tap their impound accounts to pay their annual property-tax bill.

“Impound accounts are basically unregulated today,” said Michelle Meier of Consumers Union, a nonprofit group that’s calling for stricter federal rules concerning the accounts.

“Homeowners have billions of dollars socked away in these accounts, and there’s virtually no (government) oversight of how lenders handle the money. Nobody is looking out for the consumer.”

Meier and some other consumer advocates are particularly perturbed over the way that lenders calculate the amount of money that borrowers must keep in their impound accounts.

If all lenders used simple arithmetic to determine how much a borrower should pay into their accounts, the monthly levy would be one-twelfth of the homeowner’s annual charge for hazard insurance or property taxes.

Balances Fluctuate

But since taxes and insurance premiums change every year--coupled with the fact that they usually come due in different months--balances in the accounts can fluctuate greatly. That makes it hard for borrowers to determine whether they’re being charged the proper amount.

Making matters even more complicated, federal law allows lenders to keep an amount equivalent to two months’ worth of impound payments in reserve as a “cushion.”

The two-month cushion protects a lender in case a bill comes due but there’s not enough money in the account because another bill has recently been paid or the buyer is behind on his payments.

Lenders earn interest on the cash that’s deposited in their borrowers’ impound accounts by putting the money in Treasury securities, money-market funds or other types of conservative investments until the borrower’s insurance or tax bill comes due, a strategy called “playing the float.”

Since most impound accounts have hundreds or even thousands of dollars in them and even the smallest of servicers handles tens of thousands of loans, the money generated by the float can run into millions of dollars.

Consider a mid-sized servicer that has 100,000 loans, each with an average impound balance of $750. Even if the bank earns a mere 3% on that money by investing in short-term notes, its float will be $2.25 million a year--$187,500 a month.

The bigger the servicer, the more it can earn from the float.

A large company that processes 500,000 loans with an average impound balance of $750 each could easily earn more than $10 million a year by investing the money that its borrowers have deposited in their escrow accounts.

“The float is one reason why loan servicing is so attractive,” said Lionel Punchard, a mortgage broker and president of First Republic Mortgage Corp. in Santa Ana. “It lets you make money by using other people’s money.”

In most states, lenders are allowed to keep earnings from the float for themselves: Only California and 13 other states require financial institutions to pay interest on their borrowers’ impound balances.

Minimal Interest Paid

Even in states where lenders are required to pay interest on impounds, the amount that homeowners earn each year is minimal. In California, for example, lenders must pay only 2% interest on the impounds they collect.

Consumer groups say that it’s unfair for lenders to use their borrowers’ money to earn interest for themselves. They’d like to see a federal law passed that would require lenders in every state to pay rates on impounds that are competitive with, say, the rates consumers can earn from money funds or comparable investments.

“Banks are taking interest that rightfully belongs to their borrowers,” said Meier of Consumers Union.

Meier and some other consumer advocates had thrown their support in the congressional session that ended in October behind an ill-fated proposal that would have ordered all lenders to pay at least 5 1/4% on impound balances.

The bill, authored by House Banking Committee Chairman Henry B. Gonzalez (D-Tex.), would also have allowed borrowers to drop their impound accounts and pay their bills themselves when their outstanding loan balance fell below 80% of their original loan amount.

Although the Gonzalez bill had several co-sponsors, the proposal came under heavy attack from banking lobbies and died after being bottled up in committee hearings.

“It was just one of those times when some industry groups wanted to block reform legislation, and they succeeded,” Meier said. “All we can do is start from scratch next year with a brand-new Congress.”

Added Larry Powers of Consumer Loan Advocates, an Illinois-based company that checks for billing errors on borrowers’ accounts: “The bankers . . . really put on a full-court press against this bill.

“They don’t want to lose the use of all that ‘free money,’ and it could cost them millions if they have to pay 5 1/4% on the money that’s impounded.”

Bob O’Toole, senior vice president of the Mortgage Bankers Assn. of America and one of the bill’s biggest opponents, said that forcing servicers to pay 5 1/4% on their borrowers’ impound balances may only hurt consumers in the long run.

“There’s no such thing as a free lunch,” O’Toole said.

“If banks or servicers have to pay 5 1/4%, they’re going to have to recoup that money somehow,” O’Toole said. “They’re going to have to charge more points on new loans or charge higher interest rates.”

Leeway in Accounting

Another key element of Gonzalez’s bill was designed to resolve a conflict between the Real Estate Settlement Procedures Act of 1974 (RESPA) and regulations published by the Department of Housing and Urban Development--a conflict that will apparently continue now that the bill has died.

RESPA specifically gives lenders the right to keep an amount equivalent to two months’ worth of impound charges in reserve in case a bill comes due but there isn’t enough money in the account to pay it.

HUD, however, allows lenders some leeway in choosing which type of accounting method they can use to calculate a borrower’s impound payments. Even HUD officials admit that some of those methods allow lenders and servicers to exceed the two-month cushion rule.

The two most common methods of calculating impound payments are known as “single-item” analysis and “aggregate” analysis.

Most lenders and servicers use the single-item method, which critics complain allows them to exceed the two-month cushion and generate more “free money” to play the float.

Single-item analysis usually involves setting up several “sub-accounts”--one for the borrower’s property taxes, another for fire insurance, a third if a flood-insurance policy is needed, a fourth for any voter-approved sewer or school taxes and so on.

Money in one sub-account can’t be used to offset a shortage in another sub-account, meaning that the homeowner may get hit with a special assessment to make up for a shortfall in one account even if an overage exists somewhere else.

“It’s the easiest, simplest way for a lender to keep track of impound deposits and payments,” said O’Toole, the executive with the Mortgage Bankers Assn.

“You just look at each sub-account, and you know exactly how much you have saved up for taxes, how much you’ve got saved for insurance and so on.”

Simplicity aside, consumer advocates say lenders should instead be required to use the “aggregate” method to calculate impound payments. It treats all the money as a single account, so excess funds in one area can be used to make up for shortfalls in others.

“The single-item method lets lenders pump up their accounts far above the two-month ‘cushion’ that federal law allows them to have,” complained Al Sheldon, a deputy attorney general who represented California in a lawsuit against servicing giant GMAC that will eventually result in refunds to more than 300,000 borrowers.

“The trouble is, HUD just won’t enforce the law,” Sheldon said. “HUD has basically dumped the job in our laps and said, ‘You guys deal with it.’ ”

2-Month Cushion Rule

HUD’s chief lawyer, Frank Keating, admits that his own agency’s regulations allow lenders to violate RESPA by keeping more than a two-month cushion in reserve.

But even though HUD regulations may conflict with RESPA, Keating said, his agency doesn’t have any legal authority to pursue violators.

“We’ve asked Congress to resolve this conflict, and we’ve asked Congress to give us the power to enforce the two-month cushion rule,” Keating said. “So far, we’ve gotten neither.”

Keating said HUD is drafting a new regulation aimed at clarifying the use of single-item analysis.

Although the regulation would likely allow lenders to continue using either of the two accounting methods, Keating said, it would specify that single-item analysis could only be used as long as it didn’t result in a violation of the two-month cushion rule.

But borrowers shouldn’t expect to see the regulation published soon.

HUD’s proposal has already been in the draft stage for more than a year, a delay that many consumer advocates attribute to meddling by the same banking lobbies that thwarted passage of Gonzalez’s bill.

Even when HUD analysts are finished drafting the proposal, “it’ll have to go through departmental clearance, then OMB (Office of Management and Budget) and then review by Congress,” said Bill Glavin, a HUD spokesman.

“And if Congress doesn’t like it, it can send the regulation back to us and we start all over again.”

Although HUD’s lawyers say they lack the power to enforce the two-month cushion rule, some private attorneys and state officials have won a handful of multimillion-dollar settlements from servicers after suing them for violating RESPA guidelines.

One-of-a-Kind Lawsuit

In the first lawsuit of its kind, a coalition of 12 state attorneys general won a settlement earlier this year from GMAC Mortgage Corp.--the nation’s fourth-largest loan servicer--worth an estimated $100 million after charging the company with systematically forcing borrowers to keep more cash in their escrow accounts than the federal law allows.

The lawsuit followed a 1990 study, conducted by a group of six attorneys general, which estimated that the nation’s largest lenders held as much as $4 billion more in escrow funds than the two-month ceiling allows.

The class-action suit covered 380,000 GMAC customers across the country, including 45,500 in California.

The January settlement gave the company a year to recalculate all of its borrowers’ impound payments: The typical Californian with a GMAC account is expected to save between $100 and $350.

As in most recent settlements that have been reached by private-sector lawyers who brought similar class-action suits against other lenders, GMAC neither admitted nor denied any wrongdoing and said it settled to avoid the time and money needed to resolve the matter in court.

In fact, GMAC officials still maintain that their former accounting practices were not illegal and remain the industry norm.

“We were just doing it the way most other lenders do it,” said Rick Gillespie, a GMAC spokesman. “I don’t know why we were singled out. . . .”

Indeed, said Deputy Atty. Gen. Sheldon, most lenders continue to use the controversial single-item accounting method that GMAC agreed to drop.

And even though Sheldon won’t rule out the possibility of filing suits against other lenders, he points out that his staff is already stretched thin and his office lacks the financial resources to battle several institutions at once.

“We just hope the industry will take a hint from the GMAC settlement and start conforming to federal law,” Sheldon said.

Private-sector attorneys have filed about 60 similar lawsuits against other lenders and servicers since the government reached an accord with GMAC: About 10 have already been settled out of court, and negotiations continue in dozens of other cases.

Class-Action Suit

Among the highest-profile agreements:

* Shearson Lehman Hutton Mortgage has tentatively reached a settlement in a class-action suit covering 168,000 borrowers. Although terms of the proposal haven’t been disclosed, a spokesman for Shearson said the company has already refunded about $5 million to customers.

* Fleet Mortgage Corp. of Milwaukee, the nation’s No. 2 servicer with nearly 1 million loans, has tentatively agreed to return about $85 million to many of its current and past customers.

* Glendale Federal Bank of California has agreed to refund about $6.5 million to more than 130,000 borrowers.

* Memphis-based Leader Federal Bank for Savings agreed to refund $80,000 to about 90,000 customers. The settlement is being appealed, though, because some of Leader Fed’s customers say this settlement is too low when compared to others in similar cases.

“Consumers are saying, ‘I’m mad as hell, and I’m not going to take it anymore,’ ” said Daniel Edelman, a Chicago lawyer who represented homeowners in the suits against both Fleet Mortgage and Glendale Federal.

But while lawyers are having some success in their efforts to get lenders to reduce their impound charges, there’s little they can do for homeowners who say their accounts have been mismanaged by their lender or loan servicer.

And even homeowners who haven’t had any qualms with the way their escrow accounts have been handled by their original lender sometimes run into trouble when their bank or S&L; either sells their loan or transfers monthly processing duties to a new institution.

“All of a sudden you’re assigned to a new, screwed-up bank and their problems become your problems,” grumbled Vicky Mikell, whose mortgage on the home that she and her husband, Kurt, own in the Ventura County community of Oak Park was sold twice in one year.

The Mikells originally financed their purchase with a loan from a local lender, American Residential Mortgage Corp. They paid about $250 a month into an impound account that American would automatically tap when their property-tax payments came due, an arrangement that worked just fine for several years.

Then, in late 1990, American notified the Mikells that it had sold their loan to Huntington Mortgage Co. of Columbus, Ohio.

New Loan Servicer

Initially, the Mikells didn’t worry much about their new loan servicer. But then, a month or so after last year’s April 10 property-tax payment deadline had passed, the Mikells began receiving letters from the county tax collector warning that they’d face foreclosure and a tax sale if the bill wasn’t paid.

“We thought the tax collector must have made a mistake, because Huntington was supposed to pay the bill with the money in our impound account,” Vicky Mikell said.

The Mikells called the tax collector and were told no, there was no mistake: Their tax bill hadn’t been paid. So, they called their new bank.

“Huntington insisted that it had paid the bill,” Mikell said. “They couldn’t explain what had happened, and they didn’t even care. They already had our money.”

Compounding problems, while the Mikells were wrangling with both their bank and the tax collector, Huntington sold their loan to U.S. Bancorp in Texas.

“It’s like we had been cursed,” Vicky Mikell said. “Here we already had all this trouble, and then our loan gets sold to yet another bank.”

Then one day--almost mysteriously--the Mikells’ tax bill showed up on the collector’s computers as being paid in full.

What had happened, the Mikells learned, was that Huntington had indeed sent the tax collector a check in March. But the check was for several hundred thousand dollars--representing the entire amount of property taxes owed by Huntington’s hundreds of mortgage customers in Ventura County.

Although it’s common for many banks to pay all of their clients’ tax bills with one large check, they must accompany it with a breakdown of all the properties covered by the payment so each homeowner’s account can be properly credited.

“Huntington didn’t include a printout telling which parcels were covered by the check they sent us,” Ventura County Tax Collector Hal Pittman said in an interview.

“Since there’s no way for us to match up lenders with the properties they have financed, we had to send the check back to Huntington and our computers kept sending out late notices to people like the Mikells.”

Six Months to Clear Up

According to Pittman, it took Huntington several months to return the check with the required breakdown of properties. Only then was his office able to bring the Mikells’ tax bill up to date.

“It took us six months to clear up this nightmare,” Vicky Mikell said.

“How would you like to spend six months being told that you’re going to lose your home at a tax sale?” she asked. “Believe me, it’s no fun.”

Oddly, a Huntington spokeswoman claims that the bank’s records show no trace of any problems or correspondence with either the Mikells or the tax collector, even though the Mikells claim to have phoned Huntington several times and wrote it a handful of letters.

“I’ve checked it out, and there are no customer complaints on record,” said Huntington’s Paula Jacenko. “I really can’t explain it.”

The Mikells say they rue the day they set up an impound account to pay their property taxes and that they’ll never have one again.

But even homeowners who pay their taxes and fire-insurance bills themselves aren’t immune from loan-servicing problems.

Just ask Ann Kern.

Kern and her husband, Richard, bought their South Gate home 18 years ago with a loan from a nearby branch of Gibraltar Savings.

Everything went along fine until the loan was transferred to Dallas-based Lomas Mortgage Co., the nation’s eighth-largest loan-servicing company, in June of last year after Gibraltar was seized by government regulators.

Although the Kerns say that they had a copy of their hazard-insurance policy on file with Gibraltar, it apparently wasn’t forwarded to Lomas when the loan was transferred.

More Copies Requested

So in August, 1991, Lomas sent the Kerns a letter demanding that they provide another copy of their policy to ensure that Lomas’ interest in the home was protected.

According to both the Kerns and their insurance agent, a copy of the Kerns’ policy was mailed to Lomas about two weeks later. A copy was also faxed to the number that Lomas had included in its letter.

In late November, Lomas sent another letter to the Kerns demanding that they provide a copy of their insurance policy.

On Dec. 16, according to records supplied by the Kerns’ State Farm agent, another copy of the couple’s policy was mailed to Lomas and also faxed to the number that the bank included in its letter.

The Kerns thought the matter was settled when, after several telephone calls and letters, Ann Kern claims that a Lomas customer-service representative told her over the phone that a copy of the policy had been received.

But in January, Lomas sent the Kerns a notice showing that it had purchased an insurance policy for them through one of its affiliated companies.

To pay for the fire-insurance policy, Lomas tapped the only impound account that the Kerns have--a small fund that Lomas is supposed to use only to pay for inexpensive “credit-life” coverage that would pay the Kerns’ loan off if one of them died.

“I told them that I had already sent them copies of my (existing) policy, and that we weren’t going to pay them a cent for coverage we didn’t need,” Kern said.

That’s when things went from bad to worse.

Although Lomas had assessed the Kerns’ credit-life escrow account $112.50 to pay for the duplicate fire insurance, the account itself only had about $100 in it when the assessment was made.

As a result, the February statement Lomas sent to the Kerns was for $175, about $10 more than they usually paid.

A Second Policy

Since the Kerns were adamant about not paying for a second fire-insurance policy, they sent in their usual $165. The Kerns called it “fairness.”

Lomas called it a “partial payment.”

A Lomas representative claims that copies of the Kerns’ State Farm policy didn’t arrive in Dallas until March 19. By that time, the March statement had already been mailed out.

The Kerns once again sent in $165 as their payment for March, but exactly what happened next is a matter of debate. The Kerns say they sent their payment in plenty of time to avoid a late charge, but Lomas maintains that the check didn’t get to Dallas until April 2.

In any case, Lomas considered the March payment both “partial” and late. On April 1, it sent the Kerns what they call an “insulting” letter urging them to “place priority” on their monthly payments, “stop buying nonessentials” and to “seek credit counseling.”

“We own three houses and we’ve been making mortgage payments for 25 years, and here they send us this stupid letter that treats us like we’re irresponsible young kids,” Ann Kern said.

After more phone calls and letters, Lomas and the Kerns finally ironed out their differences. Lomas canceled the unwanted insurance policy and also agreed to refund the $112.50.

Even the Kerns admit that it was a fair settlement, at least from a financial point of view. “But the whole thing still bugs me,” Ann Kern said.

“They were so rude and incompetent, and there was nothing I could do except keep plugging away. It just wasn’t fair--why did I have to spend 30 or 40 hours clearing this mess up when it was all their fault to begin with?”

Loan servicers admit that they sometimes make mistakes, but claim that the number of complaints they get is minuscule when compared to the hundreds of thousands of loans they service each month.

“I have 700 employees processing more than 600,000 payments every single month,” said Terry Deyoe, executive vice president of Lomas Mortgage. “I’d be a liar or a fool to say that we don’t make an occasional mistake.

“But I’d say that in any given month, less than one-half of 1% of our borrowers have a problem. The other 99 1/2% are perfectly happy.”