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Escrow For Taxes And Insurance: A Thorny Issue

I have received a large number of questions dealing with various aspects of the escrow for taxes and insurance issue. This column will attempt to highlight what lenders can do and what they cannot do in this area.

Lenders like to escrow funds for future payment of real estate taxes and insurance. If, for example, your real estate taxes are $1,200 a year, the lender will charge you $100 per month over and above your regular mortgage payment, and this $100 per month will be held by the lender. The theory is that at the end of the year, the lender will have accumulated, on a monthly basis, $1,200, and will then be able to pay your real estate taxes out of these escrowed funds.

State laws differ dramatically, and you should check with your own attorney to determine what your local law permits. For example, in some states, a lender is required to pay interest on these escrowed funds. In many states, however, there are no such requirements, and the lender keeps your escrow interest-free

The theory behind the escrow makes sense. Lenders are concerned that if you do not pay your annual real estate taxes or if you do not pay your annual insurance premium, the lender’s security will be affected. Indeed the lender could lose the property if it burns down to the ground without insurance, or if the local government sells the property at a tax sale for non-payment of those real estate taxes. Thus, in theory, lenders want to make sure the real estate taxes and the insurance are paid, and thus they establish an escrow.

We often hear a lender refer to P-I-T-I. This stands for payments of principal, interest, taxes and insurance.

In the District of Columbia, for example, if you put down 20% or more cash equity, and the lender’s loan is 80% or less of the market value of the property, the lender must give you an election. You can pay your own taxes and insurance, or the lender will escrow and pay these items for you.

Unfortunately, while the theory makes sense, in my opinion the primary reason for wanting these escrow accounts is that lenders accumulate huge sums of money which they can use for their own benefit, without paying interest to the consumer.

Let’s face it. Most people will pay their real estate taxes and their insurance premiums, since they do not want to lose their house, or have the house uninsured in the event of a calamity. And for those borrowers who stop making their mortgage payments, the escrows also stop.

Many years ago, the Congress of the United States adopted the Real Estate Settlement Procedures Act, which, among other things, regulates these escrow accounts.

Here is a summary of the law:

It should be pointed out this law applies to all “federally related mortgage loans.” This is a very broad category, and includes loans which are secured by a first lien (deed of trust or mortgage) on residential real property including condominiums and cooperatives, and is either insured or guaranteed by a governmental agency such as the Federal Housing Administration or the Veterans Administration, or is intended to be sold by the originating lender to such secondary mortgage markets as the Federal National Mortgage Association (FannieMae) or the Federal Home Loan Mortgage Corporation (FreddieMac).

Under the law, at the initial settlement, a lender has the right to require a borrower to deposit in any 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 amount of these taxes or insurance premiums.

In our example, if the taxes come due in January, and you are settling in August, your first month’s payment will not become due until October. For the months of October, November and December you will make three months escrow payments. Since the lender will require a full year’s payment in January, it has the right to escrow nine months at settlement, plus one-sixth of the total amount, or in other words, an additional two months’ worth of escrow. These funds are to be held by the lender and paid when the taxes come due.

Basically, the same rules apply for escrow requirements after the settlement takes place on a continuing yearly basis. 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 two months’ surplus.

If there is a deficiency in the escrow account, caused, for example, by an increase in the taxes, the bank can, of course, ask you to make up that deficit.

On an annual basis, whoever services your loan must send you a statement clearly itemizing “the amount of the borrower’s current monthly payment, the portion of the monthly payment being placed in the escrow account, the total amount paid into the escrow account during the period, the total amount paid out of the escrow account during the period for taxes, insurance premiums . . . (as separately identified) and the balance in the escrow account at the conclusion of the period.” This statement must be submitted to each borrower not less than once a year.

There are penalties associated with a lender’s failure to comply with this law, but the courts are divided as to whether a consumer has the right to take the lender to court for violation of this law. One court has indicated the only remedy is to go to the appropriate governmental agency, and another court has indicated that the consumer has an individual private remedy in court.

Once you receive the annual statement, you must 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. Congressional testimony has uncovered many errors made by mortgage lenders, some in favor of the borrower and others in favor of the lender.

Here is a suggestion you should follow. When your real estate taxes and your insurance premiums are due, and if your lender is paying these items for you, write the lender and ask them for confirmation that your taxes and insurance have in fact been paid. I have been involved in too many cases where a lender, usually inadvertently, has failed to make the annual real estate tax payment, or pay the annual insurance premium, causing significant aggravation and heartache to the consumer. While the lender is legally obligated to make payments out of the escrow account, you, the consumer, are the one who will be affected, and the burden should be on you to assure yourself that these payments are, in fact, made.