New Guidelines for Escrow Accounts Take Effect

The rules of the mortgage game changed in a major way late last month, and millions of consumers across the country should reap the benefits.

As of May 24, all mortgage lenders closing newly originated home loans--whether for a house purchase or to refinance an existing mortgage--are required by federal law to handle escrow accounts under a new set of borrower-friendly guidelines. The new rules are designed expressly to end what some analysts call the most widespread, abusive practice in the home mortgage arena: Overcharges by lenders administering many of the estimated 35 million American home loans that include escrow accounts.

Lenders traditionally have used escrow accounts to accumulate funds to pay borrowers’ property taxes, insurance premiums and other recurring expenses on a timely basis. Most borrowers’ monthly payments consist of principal and interest plus some extra amount that goes into escrow. But how much in escrow can your lender demand from you every month? That’s where controversy has arisen--and where the new rules come in.

Here’s a quick guide to what borrowers can expect on all new loans closed from May 24 onward. Lenders or mortgage servicing firms have the option to convert their existing customers to the new system immediately, but in no event later than Oct. 27, 1997.

First the basics: Under federal law, your lender can require you to pay monthly escrow contributions equal to one-twelfth of the total property taxes, insurance premiums and other charges that are “reasonably anticipated” during each one-year period. If the estimated property taxes and insurance bills come to $3,600, for example, you can be required to pay $300 every month into escrow.

On top of that, federal law allows collection of a “cushion” equal to two months’ worth of escrow payments--$600 in this case. The cushion exists to protect the lender against any surprise increases in tax, insurance or other charges. At some point during each year, the balance sitting in your escrow account should drop to no more than the two-month cushion. That’s because all the bills to be paid from the escrow should have been satisfied, leaving nothing but the cushion.

Now the new rules: To help you understand what’s really going on with your escrow dollars, your lender will be required to provide you an “initial escrow account” disclosure at settlement. The disclosure will estimate how much you’ll have to put in each month to cover the specified tax and insurance charges coming due during the year. The disclosure form also requires the lender to reveal the monthly cushion amount it proposes to use. The cushion, by the way, doesn’t have to be as large as the two-month maximum permitted by law. It can be zero. In fact, some mortgage companies are expected to shift to lower--or zero--cushions to compete for cost-conscious borrowers’ business.

The disclosure form asks consumers to retain these initial estimates and then compare them with the annual escrow analysis that the lender or servicer sends them at the end of the year. What happens if there’s a discrepancy? Under the new rules, if your escrow account contains a surplus of $50 or more, the loan servicer must send you a check for the full amount within 30 days of the escrow report, no questions asked.

If there’s a shortage in your account--that is, the escrow item payments plus cushion are below the targeted level--your loan servicer can do one of several things. It can ignore the shortage--usually because the amount involved is too small to bother about. If the shortage is less than one month’s regular escrow payment, it can ask you to make up the shortfall within a month. Or, if it exceeds a full month’s escrow, the servicer can ask you to pay it in installments spread over the coming year.

Other important changes to your escrow under the new rules:

--All lenders will have to use a single, nationally uniform accounting method for computing escrow contributions on all new loans. The prescribed method produces lower required monthly payments and account balances than the technique now in most widespread use.

--Lenders won’t be allowed to pad their cushions by collecting full escrow payments for tax or other items one, two or even three months before they actually pay the bills. Property taxes have been a prime area of abuse. Some lenders, for example, have set their escrow charges to fully collect a borrower’s property taxes by July, despite the fact the local government allows tax payments without penalty by the end of September. During the interim, lenders or servicers have full use of the homeowners’ funds--without interest in most states.

Now they won’t be able to play that game--at least on loans closed from May 24 onward.

Distributed by the Washington Post Writers Group.