The Real Estate Settlement Procedures Act (RESPA) outlines specific computation and disclosure rules for escrow accounts associated with federally related mortgage loans. Federal Reserve examiners have found cases where lenders improperly modified the escrow account analysis when borrowers pay property taxes at loan closing in order to prevent a large escrow payment increase the following year. In this article, we discuss the nature of the concern and how lenders can address these situations while still complying with RESPA.
When a borrower or seller pays a property tax payment at loan closing, the borrower then has only one remaining property tax payment due during the 12-month escrow account computation period. The bank can include only this remaining property tax payment in its escrow account computation analysis. The escrow account may then have a shortage, which could lead to a substantial increase in the borrower’s monthly escrow payment in the second year. To avoid this, we have seen lenders include two property tax payments in the escrow account analysis, which can lead to an inaccurate initial deposit, monthly escrow account payment, or cushion. Lenders must use a 12-month computation period. Including two property tax payments in the escrow analysis results in a 13-month computation period.
Under RESPA, a lender has two options for preventing a significant shortage during the loan’s second year. First, the lender can explain the situation to the borrower at loan closing and provide the Consumer Disclosure for Voluntary Escrow Account Payments. HUD recommends using this disclosure when the lender believes that escrow account disbursements will increase substantially in the second year of the loan. Under this option, the borrower can pay additional funds into the account during the loan’s first year to prevent an increased payment the following year. Even if the borrower chooses not to make these additional payments, he or she will learn about the shortage that will occur in the loan’s second year. HUD provides model language for this disclosure.
Second, at any time, the bank can provide a short-year statement, which ends the current escrow computation year and begins a new escrow computation year. Under this option, the borrower’s payment will still increase during the second year, but the increase may not be as substantial, depending on when the bank completes the short-year statement. HUD provides examples of short-year statements as Public Guidance Documents, which lenders can access through the link above.