MORTGAGE ESCROW ACCOUNTS: AN ANALYSIS OF THE ISSUES

MORTGAGE ESCROW ACCOUNTS: AN ANALYSIS OF THE ISSUES

98-979 E
CRS Report for Congress
Received through the CRS Web
Mortgage Escrow Accounts:
An Analysis of the Issues
December 10, 1998
Bruce E. Foote
Analyst in Housing
Economics Division
Congressional Research Service ˜ The Library of Congress

ABSTRACT
This report discusses the rationale for mortgage escrow accounts, limits on the accounts,
recent changes in regulations covering escrow accounts on federally related mortgage loans,
and the effect of the new regulations on borrowers and lenders. The report will be updated
as soon as possible after relevant changes in law or regulation.

Mortgage Escrow Accounts: An Analysis of the Issues
Summary
Regulations covering mortgage escrow accounting procedures were
implemented in 1995 and revised in 1998. The regulations have resulted in increased
payments for some borrowers, and borrowers have written Members of Congress for
an explanation of any change in law. This report discusses mortgage escrow
accounts, the rationale for having the accounts, limits on the accounts, recent changes
in regulations, and the effect of the new regulations on borrowers and lenders.
The terms of most residential mortgages require the borrower to include, with
each monthly payment, one-twelfth of the estimated annual real estate property taxes
and hazard insurance premiums. These funds are usually deposited into an escrow
account and the lender forwards payments to the taxing authority and to the insurance
company when the payments are due at intervals throughout the year. Through the
use of an escrow account, a lender is able to protect the priority of its mortgage lien
and ensure the protection of its collateral. At the same time, the home buyer is able
to budget the property taxes and hazard insurance on a monthly basis. Some
borrowers, however, feel that they can responsibly handle the payments themselves,
and object to lenders having free use of the escrow funds they are required to pay.
On many conventional loans, the lender may waive the escrow requirement as
long as the lender reserves the right to resume collection of the escrow if there is
nonpayment of the items for which escrow had previously been collected. Neither
law nor regulation requires escrow accounts for loans guaranteed by the Department
of Veterans Affairs (VA) but lenders may require such accounts because of the rules
of the secondary market agency that may ultimately purchase the loans. As with
conventional loans, the escrow requirement of VA-guaranteed loans may be waived
as long as the lender reserves the right to resume collection of the escrow if there is
nonpayment of the items for which escrow had previously been collected. On loans
insured by the Federal Housing Administration, escrow accounts are required and the
collection of such escrows may not be waived. Escrow accounts are required for
Section 502 rural home loans guaranteed by the Department of Agriculture (USDA).
Since October 1, 1996, such accounts are required for newly originated Section 502
direct loans from USDA.
Several states require that lenders pay interest on the funds that are held in
escrow accounts. Over the years, several bills have been introduced in Congress that
would require interest on such accounts but no action was taken on any of the bills.
Section 10 of the Real Estate Settlement Procedures Act of 1974 limits a
lender’s collection of escrow funds to the amount needed to pay the bills plus a 2-
month cushion. In response to complaints that lenders had been violating these
limits, a regulation has been written that defines acceptable escrow accounting
procedures. While the intent of the regulations was to reduce the amount of
borrowers’ funds that are being held by lenders, an unintended consequence of these
new regulations is that some borrowers have been required to make increased
payments into the escrow accounts.

Contents
The Rationale for Escrow Accounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
When Are Escrow Accounts Required? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Interest on Escrow Accounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
The Size of Escrow Accounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
The Regulation of Escrow Accounting Procedures . . . . . . . . . . . . . . . . . . . . . . . . 5
Payments into Escrow Accounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Approved Accounting Methods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Calculating the Account Balances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Treatment of Surpluses, Shortages, and Deficiencies . . . . . . . . . . . . . . . . . . 7
Installment Payments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
Consequences of the Regulations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

Mortgage Escrow Accounts:
An Analysis of the Issues
Regulations covering mortgage escrow accounting procedures were
implemented in 1995 and revised in 1998. The regulations have resulted in increased
payments for some borrowers, and borrowers have written Members of Congress for
an explanation of any change in law. This report discusses mortgage escrow
accounts, the rationale for having the accounts, limits on the accounts, recent changes
in regulations, and the effect of the new regulations on borrowers and lenders.
The Rationale for Escrow Accounts
Since the late 1930s, many lenders have required that when borrowers remit
their monthly mortgage payment they also remit one-twelfth of the payment for
property taxes and hazard insurance premiums. Lenders have a financial incentive
for requiring such payments.
A tax lien is superior to a mortgage lien. If a borrower failed to pay the property
taxes, the municipality could obtain a lien on the property and force a sale of it.
From the proceeds of the sale, the municipality would collect the taxes owed it, and
any proceeds remaining would go to the mortgage holder. But such remaining
proceeds might not satisfy the debt in full. If such were the case, the lender would
be entitled to a deficiency judgment against the borrower if state law permitted such
judgments.1 The borrower, however, may not be able to pay such a judgment, for if
a borrower were able to pay a deficiency judgment, the borrower probably would not
have failed to pay the property taxes in the first place. During the “Great
Depression,” many lenders suffered losses when municipalities forced sales of
properties on which the lenders held mortgages.
Suppose a property were destroyed by fire or some natural disaster, and the
borrower did not have an insurance policy or had failed to continue premium
payments on a policy that would have covered such hazards. It is likely that a
borrower would not continue mortgage payments on the property. The lender could
foreclose the loan, but given the cost of repairing the damage, in many cases the
lender would be unable to recover the value of the borrower’s mortgage. The lender
would suffer a loss because of deterioration in the value of its collateral. Again, a
lender could be entitled to a deficiency judgment against the borrower if the amount
realized upon sale of the property were less than the amount of the outstanding
1If the lender were aware of the pending tax sale, it would be in the lender’s interest to pay
the back taxes on behalf of the borrower. If the lender were unable to prevent the tax sale,
then it may be in the lender’s interest to purchase the property at the tax sale.

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mortgage. But this would not necessarily ensure the lender’s full recovery of the
loan.
When borrowers pay their property taxes and hazard insurance through an
escrow account controlled by the lender, the lender knows that the taxes and
insurance are paid, because the lender pays them. So, through the use of an escrow
account, a lender is able to protect the priority of its mortgage lien and ensure the
protection of its collateral. At the same time, the homebuyer is able to budget the
property taxes and hazard insurance on a monthly basis. Some borrowers, however,
feel that they can responsibly handle the payments themselves, and object to lenders
having free use of the escrow funds they are required to pay.
When Are Escrow Accounts Required?
For conventional loans, the Federal National Mortgage Association (Fannie
Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) generally
require escrow accounts on first mortgages. If requested by borrowers, lenders may
waive the escrow requirement as long as the lenders reserve the right to resume
collection of the escrow if there is nonpayment of the items for which escrow had
previously been collected. Escrow accounts are not required for second mortgages,
but provision for such accounts is included in the mortgage instruments. Thus, a
lender may require an escrow account with a second mortgage if such an account is
not maintained by the servicer of the first mortgage.
As noted above, the lender may waive the escrow requirement as long as the
lender reserves the right to resume collection of the escrow. The private mortgage
insurance company, however, may prevent the lender from waiving the escrow
requirement. Generally, private mortgage insurance is required for any conventional
loan on which the borrower makes a downpayment of less than 20%. If the escrow
account is one of the conditions of the insurance, then the lender may need the
approval of the insurer to waive the escrow requirement.
Escrow accounts are required with home loans insured by the Federal Housing
Administration (FHA), but neither the law nor regulation requires escrow accounts
for home loans guaranteed by the Department of Veterans Affairs (VA). An escrow
account may be required, however, by the lender initiating the VA-guaranteed loan,
depending upon which secondary market agency purchases the loan. If a VA-
guaranteed loan is sold to become a part of a Government National Mortgage
Association (Ginnie Mae) pool, Ginnie Mae requires that the taxes and insurance be
escrowed by the lender. If the VA loan is sold to Fannie Mae or Freddie Mac, then
the lender may waive the right to collect escrows as long as the lender retains the
right to enforce an escrow requirement if the borrower fails to act responsibly.
Similarly, if the VA loan is being held by Fannie Mae or Freddie Mac and an escrow
account is in existence, the lender may, at the borrower’s request, discontinue the
escrow as long as the lender reserves the right to resume collection of the escrow if
there is nonpayment of the items for which escrow had previously been collected.

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Under the Section 502 program administered by the Department of Agriculture
(USDA), current law requires that payments for property taxes and hazard insurance
be held in escrow accounts. Homebuyers may obtain Section 502 loans to purchase
homes in rural areas in one of two ways. Low-income homebuyers may obtain direct
loans from USDA. Borrowers with income of up to 115% of the area median may
obtain USDA-guaranteed loans from private lenders. Under the guaranteed loan
program, lenders are required to establish escrow accounts for the payment of
property taxes and insurance. Since October 1, 1996, all newly originated loans
under the direct loan program have escrow accounts maintained by USDA.
Borrowers with existing Section 502 direct loans are encouraged but not required to
let USDA establish escrow accounts for their loans. If, however, existing loans have
to be reamortized or reinstated because of default, escrow accounts will be required.
Interest on Escrow Accounts
Thus, the terms of most residential mortgages require the borrower to include,
with each monthly payment, one-twelfth of the estimated annual real estate property
taxes and hazard insurance premiums. These funds are usually deposited into an
escrow account and the lender forwards payments to the taxing authority and to the
insurance company when the payments are due at intervals throughout the year. In
general, borrowers receive no interest from these accounts.
In the 1970s, consumer groups began to question this free use of the borrowers’
escrow accounts. They questioned the “Christmas Savings Club” mentality of the
lenders and argued that borrowers were mature enough to manage their own financial
affairs. They demanded a share of the profits that they believed resulted from the use
of escrow accounts. The laws, in the states noted below, are the result of lobbying
and class action suits by consumer groups.
Despite objections from some consumer groups, mortgage lenders defend the
use of non-interest-bearing escrow accounts. It is argued that lenders provide a
valuable and expensive service by accumulating the deposits and paying the bills
when they are due. Lenders argue that the system protects the homebuyer against
assessments and attachments for unpaid taxes. Furthermore, they argue, the system
provides an efficient method of tax collecting for the estimated 81,000 taxing bodies
in the U.S. They contend the escrow system enables taxing authorities to bill and
collect taxes more economically, reduces the number of tax delinquencies and the
need for advanced collection procedures, and avoids the bad check problem that is
associated with dealing with individual taxpayers. They argue that most escrow
account balances are small and are incapable of producing significant earnings.
Thirteen states and Guam require that lending institutions pay interest on escrow
accounts established to pay the property taxes and hazard insurance on mortgaged
property. The states are California, Connecticut, Iowa, Maine, Maryland,
Massachusetts, Minnesota, New Hampshire, New York, Oregon, Rhode Island, Utah,
and Wisconsin. The required interest rate ranges from 2% (California, New York
and Rhode Island) to 5.25% (Utah and Wisconsin) to the passbook savings rate
(Iowa).

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Some states provide exemptions from the interest requirements in certain
instances. In Maryland, for example, loans that are purchased by an out-of-state
lender through Fannie Mae, Ginnie Mae, or Freddie Mac are exempt from the interest
requirement if the purchasing lender elects to service the loans. Similarly,
Connecticut exempts certain loans which are sold within 6 months, if servicing is
released.
There is no federal requirement that banks pay interest on escrow accounts. The
Escrow Account System Improvement Act was introduced in the 93rd Congress
(H.R. 9315, H.R. 11460, H.R. 12275, and H.R. 13102), the 94th Congress (H.R.
5092), the 95th Congress (H.R. 826 and H.R. 6686), and the 101st Congress (H.R.
2112). The Escrow Account Reform Act of 1991 (H.R. 3524) was introduced in the
102nd Congress. All the bills contained a provision that would have required lenders
to pay interest on escrow accounts established in connection with “federally related”
mortgage loans. No action was taken on any of the bills.
The Size of Escrow Accounts
In the early 1970s, Congress found that reforms were needed in the real estate
settlement process to ensure that borrowers had more information on the cost of the
process and to ensure that borrowers were protected from unnecessarily high charges.
It was found that some mortgage lenders were requiring borrowers to keep sums in
escrow accounts that greatly exceeded the amounts required to pay the taxes and
insurance payments when due.
The Real Estate Settlement Procedures Act of 1974 (RESPA) was enacted to
address problems in the real estate settlement process. RESPA applies to all
federally related mortgage loans except for loans on property of 25 acres or more.2
One of the purposes of RESPA is to reduce the amounts homebuyers are required to
pay into escrow accounts established to insure payment of property taxes and hazard
insurance.3 Section 10 of RESPA provides that the sum of the borrowers’ escrow
account deposits over a 12-month period should not exceed the total of taxes,
insurance and other items to be paid for the period by more than one-sixth of said
total. (This is the equivalent of 2 months of escrow account payments that may be
used by the lender as a cushion against unexpected costs.) The Department of
Housing and Urban Development (HUD) was given the authority to prescribe the
rules and regulations necessary to achieve the purposes of RESPA. The HUD
regulation covering RESPA is referred to as Regulation X and is found in the Code
of Federal Regulations at 24 CFR Part 3500.
2Federally related mortgage loans are defined as any loans that (1) are secured by first or
subordinate liens on one to four unit properties (including condominiums, cooperatives, and
manufactured homes) and (2) are either made by lenders who are regulated by or whose
deposits or accounts are insured by an agency of the federal government; or are made,
insured, guaranteed, supplemented, or assisted by an agency of the federal government; or
are intended to be ultimately sold to Fannie Mae, Freddie Mac, or Government National
Mortgage Association.
3P.L. 93-533, Section 2(b)(3).

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A lender originates a loan but the lender may or may not service the loan. The
real estate mortgage market has become specialized to the point where some firms’
only function may be to service mortgage loans that have been originated by others.
The statutes and regulations regarding RESPA may at times use the term “lender”
and at other times may use the term “servicer.” The HUD regulations use the term
servicer, but HUD notes that the term includes the term lender when the lender
performs the servicing function. This report uses the term “lender” but notes that the
term includes the servicer where the servicing function is performed by someone
other than the lender.
The Regulation of Escrow Accounting Procedures
On November 2, 1992, HUD published a final rule that revised Regulation X.4
This was the first amendment to the regulation since a minor revision in 1977. Since
HUD’s escrow study was not complete, the 1992 regulation did not address escrow
accounting procedures. Part 3500.17 of the regulation, however, was reserved for
future regulations on escrow accounting. On December 3, 1993, HUD proposed to
amend Regulation X to establish escrow accounting procedures under Part 3500.17.5
A final regulation was issued on October 26, 1994.6 A subsequent final rule was
issued on February 15, 1995, in response to requests for HUD to correct, clarify, or
further illustrate matters contained in the October 1994 rule.7 A subsequent final rule
was also issued on May 9, 1995, to correct and clarify issues addressed in the
previous rules.8 Regulation X was revised again on September 3, 1996, September
24, 1996, November 15, 1996, and most recently on January 21, 1998.9 The
following sections present the requirements for escrow accounts established in
connection with federally related mortgage loans.
Payments into Escrow Accounts
At settlement or upon creation of an escrow account, the lender may charge the
borrower an amount sufficient to pay the taxes, insurance, and other charges
attributable to the period such items were last paid until the first payment into the
escrow account. In addition, the lender may charge the borrower a cushion that does
not exceed one-sixth of the estimated annual payments from the escrow account.
A lender must examine the mortgage loan documents when determining the
escrow account cushion. If the loan documents provide for a lower cushion than
Regulation X, then the terms of the loan documents apply. If the loan documents
allow greater payments than the regulation, then the regulation applies. If the loan
457 FR 49600.
558 FR 6406.
659 FR 53890.
760 FR 8812.
860 FR 24734.
961 FR 46510, 61 FR 50208, 61 FR 58472, and 63 FR 3214.

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documents do not specifically establish an escrow account, then whether the lender
may establish an escrow account is determined by state law. The limits of Regulation
X will apply unless state law provides for lower limits.
Throughout the life of the escrow account, the lender may charge the borrower
a monthly sum equal to one-twelfth of the annual escrow payments that the lender
anticipated paying from the account. In addition, the lender may add an amount to
maintain a cushion of no more than one-sixth of the estimated annual payments from
the account.
Before establishing an escrow account, the lender must conduct an escrow
account analysis to determine the amount the borrower is required to deposit into the
escrow account, subject to the limitations noted above. The lender must also conduct
an escrow account analysis at the end of the escrow account computation year to
determine the borrower’s monthly escrow account payments for the next year. Upon
completion of the escrow account analysis, the lender must submit an annual escrow
account statement to the borrower.
Approved Accounting Methods
Since May 24, 1995, all newly established escrow accounts must use the
aggregate accounting method when evaluating the escrow account balances. Under
aggregate accounting, a lender conducts escrow account analysis by considering the
account as a whole when computing the sufficiency of escrow account funds. In
prior years lenders were permitted to use single-item accounting, under which each
escrow account item was considered separately when analyzing the sufficiency of
funds. The use of single-item accounting was outlawed because it often resulted in
escrow account balances exceeding the RESPA limits.
A 3-year phase-in period (which ended on October 27, 1997) applied to existing
escrow accounts, after which the accounts had to be converted to aggregate
accounting. During the phase-in period, the transfer of the servicing of the loan did
not convert the escrow account into one requiring aggregate accounting. If the loan
were refinanced, whether by the same or a new lender, then the lender had to use
aggregate accounting for the escrow account.
Calculating the Account Balances
The regulation establishes the arithmetic steps that a lender must use to
determine whether its use of an accounting method conforms with the limitations of
the regulation. The steps are as follows: (1) The lender projects a trial balance for the
account as a whole over the next computation year. The lender assumes that the
borrower will make monthly payments of one-twelfth of the estimated annual
disbursements. The lender also assumes that disbursements will made on or before
the deadline to avoid penalties and to take advantage of any available discounts for
early payment. (2) The lender examines the monthly trial balances, adds to the first
monthly balance an amount that will bring the lowest monthly trail balance to zero,
and adjusts all other monthly balances accordingly. (3) The lender adds to the
monthly balances the permissible cushion. The cushion will be 2 months of the

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borrower’s escrow account payments or the lesser amount specified by state law or
the mortgage documents. The cushion will be net of any increases or decreases
because of prior year shortages or surpluses.
The above steps result in the maximum escrow account balances permitted by
the regulation. Lenders may use accounting methods that result in lower balances,
and lenders may use a smaller cushion or no cushion at all.
Treatment of Surpluses, Shortages, and Deficiencies10
If an escrow account analysis reveals a surplus, the lender must, within 30 days
of the analysis, refund the surplus to the borrower if the surplus is $50 or more. If
the surplus is less that $50, the lender has the discretion of refunding the amount to
the borrower or crediting the amount against the next year’s escrow payments. If,
however, the borrower’s loan payments are not current, the lender may retain the
surplus according to the terms of the loan documents.
If an escrow account analysis reveals a shortage of less than one month’s escrow
account payment, the lender has three options: (1) allow the shortage to exist and do
nothing to change it, (2) allow the borrower to pay the amount within 30 days, or (3)
allow the borrower to repay the shortage in equal monthly payments over a 12-month
period. If an escrow account analysis reveals a shortage of one month or more of
escrow account payments, the lender has two options: (1) allow the shortage to exist
and do nothing to change it, or (2) allow the borrower to repay the shortage in equal
monthly payments over a 12-month period.
If an escrow account analysis reveals a deficiency, then the lender may require
the borrower to pay additional monthly deposits to eliminate the deficiency. If the
deficiency is less than one month’s escrow account payment, the lender has three
options: (1) allow the deficiency to exist and do nothing to change it, (2) require the
borrower to pay the amount within 30 days, or (3) allow the borrower to repay the
deficiency in equal monthly payments over a 12-month period. If the deficiency
equals one month or more of escrow account payments, the lender has two options:
(1) allow the deficiency to exist and do nothing to change it, or (2) allow the
borrower to repay the deficiency in equal monthly payments over a 12-month period.
Installment Payments
In some jurisdictions, property taxes or insurance may be payable on a quarterly
or semi-annual basis. In the past, lenders have actually paid these charges annually.
The 1994 regulation provides that, unless there is a discount to the borrower for early
10A surplus is defined as the amount by which the escrow account balance exceeds the target
balance for the account. A shortage is defined as an amount by which the escrow account
balance falls short of the target balance at the time of the escrow analysis. A deficiency is
defined as the amount of a negative balance in the escrow account. The target balance is the
estimated balance, given the scheduled periodic payments and any cushion, that is just
sufficient to cover the disbursements from the account in the escrow account computation
year.

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payment, lenders must pay such charges on an installment basis if jurisdictions
permit installment payments. A problem with implementing the rule was whether
disbursements from mortgage escrow accounts should be made on an annual or
installment basis if the payee offers a choice. In some cases, a switch from
installment to annual disbursements, required under certain circumstances under the
rule, resulted in greater payments to escrow accounts for some borrowers and adverse
tax consequences for some borrowers.
In January 1998, HUD revised the rule to provide that lenders must make
payments that are on or before the deadline to avoid a penalty, and to advance funds
as necessary, so long as the borrower’s payment is not more than 30 days overdue.
The rule also provides special requirements for property taxes when the taxing
jurisdiction offers the lender a choice between installment disbursements and annual
disbursements with a discount. In such cases, if the taxing jurisdiction neither offers
a discount for disbursements on a lump sum annual basis nor imposes any additional
charge or fee for installment disbursements, the lender must make disbursements on
an installment basis, unless the lender and borrower agree otherwise. If, however, the
taxing jurisdiction offers a discount for disbursements on a lump sum annual basis
or imposes any additional charge or fee for installment disbursements, the lender
may, at the lender’s discretion (but is not required by RESPA), make lump sum
annual disbursements. HUD encourages, but does not require, the lender to follow
the preference of the borrower, if such preference is known to the lender.
This 1998 rule also incorporates into the regulations a provision that the lender
and borrower may mutually agree, on an individual case basis, to a different
disbursement basis (installment or annual) or disbursement dates, than the rule would
otherwise require.
The 1998 rule emphasizes that these agreements must be completely voluntary
and that neither loan approval nor any term of the loan may be conditioned on the
borrower’s agreeing to a different disbursement basis or disbursement date for
property taxes. The rule does, however, allow such agreements to be made prior to
settlement. This rule also clarifies that the agreement must avoid a penalty, comply
with normal lending practice of the lender and local custom, and constitute prudent
lending practice.
Note that, under this final rule, the only specific requirements for choosing
between annual and installment disbursements pertain to property taxes, not other
escrow items. The reason HUD distinguishes property taxes from other escrow items
is that the concerns that have been raised have been limited to property taxes. For
most consumers, property taxes are much larger than hazard insurance and other
escrow items.
Consequences of the Regulations
The intent of the new regulation was to lower the amount of borrowers’ funds
that lenders would be holding during the year. Many borrowers, however, have
received notices from their lenders informing them that their payments are increasing.

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Some notices apparently contain a statement that the increased payments are required
by recent changes in federal law regarding RESPA. Several borrowers responded by
writing to Members of Congress and asking why Congress would pass legislation to
require borrowers to pay more funds to lenders.
Of course, no change in statute has taken place, a change in the regulations
implementing the act has occurred. To a lender, the distinction between laws and
regulations is not meaningful. The lender has been informed that the federal
government has changed the rules regarding some aspect of the way the lender’s
business is conducted, and the lender has to comply. From the lender’s perspective,
it is irrelevant whether the change was by statute or by regulation.
The increased borrower payments may be an unintended consequence of the
new regulations, and may be explained by several factors. As noted above, Section
10 of RESPA established that lenders may collect no more than 2 months of escrow
account payments as a cushion. The 2-month cushion is a “ceiling,” and there is no
requirement in law or regulation that lenders accumulate any cushion at all.
Traditionally, many lenders have correctly interpreted the law and regulation, and
have accumulated no cushion or have accumulated a smaller cushion than permitted
by RESPA.
The new regulations created a standard format that lenders may use when
determining the maximum escrow account balances and monthly payments for the
next 12-month period. If lenders follow the format, they will automatically create an
account where the lender is accumulating the maximum permitted by RESPA. If
those lenders who traditionally accumulated little or no cushion follow the format
established in the new regulation, then the lenders would begin to accumulate the
maximum cushion permitted by RESPA. The borrowers would be required to
increase their monthly payments. This may explain why some borrowers have
received notices that their payments are increasing.
This result does not have to be obtained, however. The resulting payments that
are calculated when lenders use the new format are still maximums. Lenders would
be in violation of RESPA if they required borrowers to pay more than the amounts
calculated, but it would not be a violation for lenders to require borrowers to pay less.
The payment possibilities for the borrower range from (1) that amount that would
simply permit the lender to pay the bills as they come due to (2) the amount in (1)
plus a 2-month cushion.
The new regulation has required lenders to revise their escrow accounting
systems and, in the process, has given lenders the opportunity to examine the
economics of their escrow accounting practices. Upon examination, many, who have
not done so in the past, have opted to exercise their right to accumulate the largest
escrow account as permitted by law and regulation. Some lenders, however, may not
have been completely forthright when notifying borrowers of increases in monthly
payments. Instead of stating that the lenders were exercising a right that they always
had, the lenders may have given the borrowers the impression that the change is due
to some change in law. There is also the possibility that some lenders may not realize
that the HUD regulation sets an upper limit and that they still have a choice when
determining the actual payments that the borrowers make. Part 3500.17(d) of the

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new rule specifically states, however, that the steps set forth in the regulation derive
maximum limits and that lenders are free to choose a smaller cushion or no cushion
at all.
Another factor could cause the borrowers’ escrow account payments to increase
under the new regulations. In certain localities, property taxes are paid on other than
an annual basis. The new regulation permits lenders to change to annual payment if
the locality provides a discount for such payment. The borrower’s monthly payment
may increase in the first year of such a change, if the lender needs to ensure that
sufficient funds will be available to pay the annual taxes.
The choice of disbursement methods has consequences for borrowers. In
general, disbursements from an escrow account in installments work to the
borrower’s benefit, because, on average, they result in lower up-front payments
(lower closing costs) to establish the account.
If an existing escrow account is switched from installment disbursements to a
single annual disbursement, the borrower may have to increase the monthly escrow
deposits. In addition, depending on the timing of the disbursements, the change may
have tax consequences for the borrower. The required change to installment
payments has had negative income tax consequences for some borrowers.
The form that the lender sends to the Internal Revenue Service (IRS) and to the
borrower shows the amount of funds that the lender has paid on behalf of the
borrower during the tax year. If the lender begins to pay the property taxes in
installments, depending on the timing of the installment payments, the lender may
only have one installment to report to IRS. So the value of the borrower’s income
tax write-off for property taxes may not reflect the amount of such payments that the
borrower has actually remitted to the lender during the tax year. This effect only
occurs during the first year of the implementation of the change.
Escrow account payments may be increased because of increases in the property
taxes or increases in the insurance premiums. Lastly, escrow account payments may
be increased to eliminate a shortage or deficiency revealed by the annual escrow
account analysis.
As noted above, the phase-in period for implementing the aggregate escrow
accounting method ended on October 27, 1997. Depending on the timing of annual
review of the escrow account balances, many borrowers would only notice a change
in 1998.

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References
Federal Home Loan Mortgage Corporation. Sellers’ and Servicers’ Guide. Federal
Home Loan Mortgage Corporation. Washington, DC. Regularly updated.
Federal National Mortgage Association. Selling Guide. Federal National Mortgage
Association. Washington, DC. Regularly updated.
Fish, Gertrude S. Housing Policy During the Great Depression, In The Story of
Housing. New York, Macmillan Publishing Co., Inc., 1979. pp. 177-241.
Mitchell, J. Paul. The Historical Context for Housing Policy, In Federal Housing
Policy and Programs: Past and Present. New Jersey, Center for Urban Policy
Research, 1985. pp. 3-17.
Mortgage Bankers Association of America. State Legislative Compilations: Selected
Summaries of Real Estate Finance Laws. Washington, DC. 1995.
U.S. Department of Housing and Urban Development. Amendments to Real Estate
Settlement Procedures Act Regulation (Regulation X) — Escrow Accounting
Procedures. Federal Register, v. 63, no.13, January 12, 1998. pp 3214- 3237.
—— Escrow Management for Single-Family Residential Property: Phase 1 Report.
[Washington] 1991.
—— Escrow Management for Single-Family Residential Property, Phase 2: Report
on Servicer Survey. [Washington] 1992.
—— Real Estate Settlement Procedures Act (Regulation X). Federal Register, v. 57,
no. 212, November 2, 1992. pp. 49600-49625.
—— Real Estate Settlement Procedures Act (Regulation X); Escrow Accounting
Procedures. Federal Register, v. 58, no. 231, December 3, 1993. pp. 64066-
64079.
—— Real Estate Settlement Procedures Act (Regulation X); Escrow Accounting
Procedures. Federal Register, v. 59, no. 206, October 26, 1994. pp. 53890-
53992.
—— Real Estate Settlement Procedures Act (Regulation X); Escrow Accounting
Procedures. Federal Register, v. 60, no. 31, February 15, 1995. pp. 8812-8839.
—— Real Estate Settlement Procedures Act (Regulation X); Escrow Accounting
Procedures: Correcting Amendment and Clarifications. Federal Register, v. 60,
no. 89, May 9, 1995. pp. 24734-24741.
—— Real Estate Settlement Procedures Act; Statement of Approved Accounting
Methods under Section 10. Federal Register, v. 58, no. 12, January 21, 1993.
pp. 5520-5522.

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Van De Kamp, John, Robert A. Butterworth, Thomas J. Miller, James M. Shannon,
Hubert H. Humphrey, III, Robert Abrams, and Jim Mattox. Attorneys General
of California, Florida, Iowa, Massachusetts, Minnesota, New York, and Texas.
Overcharging on Mortgages: Violations of Escrow Account Limits by the
Mortgage Industry. 1990.