YOUR MORTGAGE : New Rules For Loan Escrows

Millions of American homeowners would be affected by controversial new mortgage escrow rules scheduled for unveiling by the Clinton Administration later this month. Some borrowers could eventually see their monthly payments drop as a result of the new rules, but others might actually experience a net increase.

In their current, draft form the regulations would require most mortgage lenders nationwide to overhaul their method of computing consumers’ escrow accounts on all new mortgages, and to do the same for all existing home loans during the coming three years.

The rules would also require mortgage lenders to provide far more detailed and intelligible annual reports to all borrowers--existing or new--on their escrow account balances and expenditures, tracking the flow of funds month-by-month.

When issued in final form, the new rules expected from the Department of Housing and Urban Development (HUD) should put at least a partial damper on one of the hottest consumer issues in the housing field during the past several years: Have lenders been massively overcharging borrowers by padding escrow accounts? Lenders deny that charge, and even a HUD investigation concluded that many mortgage companies undercharge customers on their escrow collections. But a group of influential state attorneys general insist that their own probes have revealed that unsuspecting homeowners are being hit with billions of dollars of unnecessary mortgage payments every year because of lenders’ “creative” escrow computations.

Escrow accounts are found in about 78% of the 40 million residential first mortgages and deeds of trust, according to Census and industry estimates. Homeowners’ monthly payments on mortgages with escrows are divided into two parts: The bulk of the payments cover interest charges and principal reduction. But a second chunk goes into a separate pot--the escrow account--to handle upcoming property tax, insurance and other periodic expenses. The mortgage company servicing the loan makes those payments on the borrower’s behalf.

For example, out of a monthly mortgage payment of $2,000, roughly $1,500 might go for principal and interest. The $500 balance would land in the escrow account. When bills like property taxes or insurance premiums came due at various times during the year, the account would need to have enough money on deposit to pay the correct amount.

Under federal law, lenders can collect monthly mortgage escrow charges equal to one-twelfth of the combined annual insurance, property tax and other expense items anticipated over the course of the year. They are also permitted to build up a two-month “cushion” or reserve in the account to cover unexpected increases in those costs. Federal law explicitly requires that at least once during the year, the balance of funds in any mortgage escrow account must drop to the two-month reserve level or lower. But mortgage industry critics say that as many as two-thirds of all existing escrow accounts never reach the statutory two-month low point, and frequently go no lower than four or five months’ worth of payments.

Lenders do this, critics charge, by using what’s called the “single-item” accounting method. Rather than treating the escrow account as a unitary pot of money, the single-item method allows lenders to treat each expense item as a sub-account. Escrowed money on hand that’s deposited in the “insurance” sub-account, in other words, cannot be used to pay a property tax bill that comes due. By maintaining two-month cushions for each escrow sub-account, lenders may be able to hold far larger total balances than they would by treating each escrow as a unitary account.

The Clinton Administration--via HUD secretary Henry Cisneros--has decided to throw its lot with the pro-consumer critics of single-item accounting, according to the draft rules. If issued in their present form, the regulators would force all lenders to adopt the so-called “aggregate” method of escrow accounting on all new mortgages. That method requires escrows to be handled as single pots of money, not a group of sub-accounts.

The rule would cover every new escrow account created after the effective date of the proposed rules--probably beginning sometime in late spring or the summer of 1994. Lenders would then be given up to another three years to change their computer programs and documents to adopt aggregate-method accounting for all loans predating the new rules.

The regulations would also spell out tough new lender-disclosure requirements on escrows. Every borrower would have to receive detailed reports on how his or her escrow account balance was arrived at, and how the funds moved in--and out--month by month.

The upshot of all this for you? Since the new rules will be issued first in proposed form, the mortgage industry will have an opportunity to fight the provisions it considers most onerous--especially the retroactive coverage of existing mortgages. Ironically, according to HUD’s own studies, forcing the entire mortgage industry onto one escrow-accounting standard may mean higher charges to consumers whose lenders routinely undercharge at present.

Best advice: Stay posted. And watch for better disclosures on your lender’s escrow practices, at the very least.