Q: We have owned our house for many years, and the lender has always escrowed money to pay our real estate taxes and insurance. This year, we received a notice from the lender that our monthly mortgage payment will increase by over $400 because there is an escrow shortage. Can we cancel the escrow requirement? If not, how do we determine whether the lender is correct?
A. I seriously doubt that your lender will allow you to cancel the escrow portion of your mortgage payment. Although lenders claim that the escrow requirement is to make sure that all taxes and insurance payments will be made, in my opinion, the real reason for escrows is that lenders make a lot of money collecting these monthly payments. Usually, lenders do not pay interest on escrowed funds. But to add insult to injury, most lenders will charge the borrower a one-time "set up" fee -- ranging from $60 to $75, which must be paid at settlement.
I also find it interesting that when subprime mortgages were being made, those lenders did not require their low-income borrowers to escrow. If the mortgage was from a predatory lender, it was designed with the view that the borrower would shortly go into default, and the lender would foreclose and start all over again with another unsuspecting homeowner.
The word "escrow" means to put something -- such as a deed or money -- in the custody of a third party until certain conditions are met. In the mortgage arena, the lender collects, on a monthly basis, one-twelfth of the annual real-estate tax bill and the annual hazard-insurance premium. When the tax or insurance bill comes due, the lender uses those escrowed funds to make the payment.
Over the years, I have received many questions dealing with the escrow for taxes and insurance. Most of the inquiries involved lenders who -- for one reason or another -- failed to pay the tax or insurance premium on time.
Many years ago, Congress adopted the Real Estate Settlement Procedures Act (RESPA), which, among other things, regulates escrow accounts. Because of major consumer objections and concerns, Congress in 1990 amended the Act and also imposed strict reporting requirements on lenders.
Under the law -- unless local law requires otherwise -- at the initial settlement, a lender has the right to require a borrower to deposit in an escrow account to be established for the payment of taxes or insurance a sum not to exceed the amount of these actual charges, plus one-sixth of the estimated total for taxes or insurance premiums. In other words, the lender is permitted a two-month cushion.
This law applies to all "federally related mortgage loans." This is a very broad category -- which includes loans secured by a first lien, a deed of trust or mortgage on residential real properties, including condominiums and cooperatives -- and is either insured or guaranteed by a government agency, such as the Federal Housing Administration or the Department of Veterans Affairs. It also applies to loans intended to be sold by the originating lender to such secondary mortgage markets as Fannie Mae or Freddie Mac.
Let's look at this example for a District home. The tax year is Oct. 1 through Sept. 30. You, the buyer, are settling on March 15. The tax bill for the first half (Oct. 1 to March 31) will be collected by the settlement attorney. The seller will be charged for the full tax that is owed, but since you will own the property as of March 15th, you will be charged for 17 days, and the seller will get a credit for the same amount.
The next tax bill must be paid by Sept. 15 (for the period April 1 to Sept. 30). Mortgage interest is paid in arrears, so your first monthly payment will not be due until May 1 (although at settlement you will have to pay your lender for the 17 days between settlement and March 31. In September, the lender will need six months escrow payments to cover the real-estate tax. But the lender will only have collected five months worth of tax escrow (May through September), so at closing you will be charged three months of tax escrow. This will give the lender the full six months' worth of payments to cover the tax bill plus the two-month cushion.
The new Good Faith Estimate that lenders are required to give to buyers will tell you if the lender requires escrow, and if so, the amount of the monthly payment.
These escrow rules apply on a continuing yearly basis until you pay off your loan. In other words, the lender has the right to hold two additional months escrow, on the theory that if you are delinquent in one or two of your monthly payments, the lender will still have sufficient funds by tapping into this cushion.
Every year, the lender servicing your loan must send you a statement clearly itemizing the amount of your current monthly payment, the portion of that payment being placed in the escrow account, the total paid into the escrow account during the period, the total paid out for taxes and insurance, and the balance in the account at the end of the period.
Once you receive the annual statement, review it carefully. Confirm with your taxing authority and with your insurance company exactly when the payment is due and the amount of that payment. Sit down with a calculator and determine whether the lender has properly calculated the amount of the escrow.
I have seen far too many cases where lenders inadvertently do not make the required real estate tax payment on time -- or at all. Often, the first the homeowner learns of the nonpayment is when he receives a notice of tax sale from the local government. I strongly suggest that every homeowner required to escrow for taxes and insurance write their lender once a year (or twice in the District of Columbia) demanding proof of payment of their real estate tax and insurance premium. If the lender does not respond promptly, contact your appropriate tax authority to confirm payment of these taxes, and complain about the lack of response to your state or local financial regulatory authority.
District of Columbia residents should keep in mind that if they have 20 percent or more equity in their property, they have the absolute right to receive a notice from the lender informing them of their right to pay their own taxes and insurance without escrow. Some lenders try to increase the mortgage rate when the borrower opts to avoid escrow. In my opinion, this is not legal and should be contested. You should not have to pay extra in order to obtain the benefits provided you by law.
Escrow for taxes is, unfortunately, a way of life in the mortgage industry. However, as a borrower, you have the right to review, analyze and complain should you find that your escrowed funds are not being handled properly. After all, these escrowed funds belong to you until they are paid to the taxing authority or the insurance company.