When a home mortgage transaction includes a provision for escrow, as most do, the borrower is required to pay a fixed amount every month in addition to the payment covering interest and principal. This escrow payment is deposited into a fiduciary account from which the company servicing the loan makes payments for taxes and insurance as they come due.
In previous articles on escrows, I gave convenience as the major advantage to the borrower, and loss of interest on the escrow account as the major cost. I also mentioned the possibility that the lender might accidentally fail to make the payment, which could result in a tax delinquency or a cancelled homeowner’s insurance policy. These are serious matters, to be sure, but I viewed the risk as very small.
More recently, however, I became aware of another risk associated with changes in required escrow payments. When taxes or insurance premiums increase, monthly escrow payments must increase as well. What happens if, for some reason (including poor communication from the servicer), the borrower fails to increase the payment?
A letter from a particularly alert borrower who noticed an increase in his tax escrow payment when he happened to know that new tax rates had not yet been posted provoked this question. He discovered that the lender had anticipated a very large increase, and had increased his escrow payment accordingly. When the borrower requested an explanation, a process that took hours of his time, the servicer had none to give, and ultimately rescinded the increase. The circumstances surrounding this incident make it extremely unlikely that it was a mistake.
What would have happened, I wondered, if this borrower, instead of investing many hours getting to the bottom of the tax escrow payment increase, which resulted in getting it rescinded, sent in his regular monthly mortgage payment including the previous escrow amount? I posed this question to Marie McDonnell, who has audited hundreds of loans for homeowners in distress, and knows more about the seamy side of loan servicing than anyone I know.
I would have assumed (and I suspect most borrowers would as well) that the servicer would credit the interest and principal payment as usual, deposit the escrow funds into the escrow account, even though it was short, and send another message to the borrower to remedy the shortage or face a tax delinquency. Not so, says McDonnell. She says that the entire mortgage payment will be placed in an ‘unapplied’ or ‘suspense’ account where it will sit in limbo until the next payment is made. The borrower will be charged a late fee, and a 30-day delinquency notice will be sent to the credit bureaus.
If the servicer does not send out monthly statements, which many do not, the borrower will have no idea about what is going on. The next month’s regular mortgage payment will also be deposited into the suspense account, which now has enough to cover one full payment, including the increased amount demanded for escrow. But the borrower incurs a second late charge and a second 30-day delinquency report.
At this point, according to McDonnell, the account is sent to the collections department where a pre-foreclosure notice is generated and a demand letter is sent to the borrower, who now suddenly finds him- or herself liable for a series of costs manufactured for the occasion. These include fees to cover a broker’s price opinion, property inspection fees, legal fees, statutory foreclosure costs, and a new high-cost hazard insurance policy that covers the lender only.
To cure what McDonnell terms a “servicer-manufactured default,” the borrower must pay the full amount necessary to bring the account current. “For consumers who do not have sufficient savings and who are living from paycheck to paycheck, the likelihood of an extended delinquency and ultimate foreclosure is very high … servicing abuse in escrow accounts … is the leading cause of premature and wrongful foreclosure.”
The impetus for this series of events is the pernicious practice of placing the entire monthly payment in a suspense account when only the escrow account is short. How widespread is this practice? McDonnell believes that all servicers do it, and she may be right, but I cannot confirm this. I also don’t know how many servicers are that quick to shift a loan into collections. There is virtually no public information available about these and many other important servicing practices.
In the months to come, I plan to remedy this. Meanwhile, when you receive a notice of an escrow payment increase, pay it. If you believe the increase is unwarranted, send the servicer a qualified written request disputing it, following the procedures outlined in the Real Estate Settlement Procedures Act. For guidance, see the article “Is There Recourse Against Bad Servicing” on my Web site.
The writer is professor of finance emeritus at the Wharton School of the University of Pennsylvania. Comments and questions can be left at www.mtgprofessor.com.
