During the purchase of a home, the lender often creates an escrow account that is used to hold funds for paying property taxes, private mortgage insurance and property insurance. The funds are held until they are needed to pay one or more of these expenses. The lender or escrow manager is responsible for making these payments on time. Account overages must be handled according to specific laws, including amounts to be returned to account holders, and lenders are subject to stiff penalties if they mishandle escrow funds.
The Real Estate Settlement Procedures Act, known as RESPA, regulates the formation and handling of escrow accounts. Lenders are not required to create such accounts but may choose to do so as a means of protecting their investment by ensuring that taxes and insurance payments are made as required. Many lenders also maintain as much of a cushion in the account as possible, typically about one-sixth of the annual total of escrow payments. Most states do not require that lenders pay account holders interest on this money.
RESPA requires that lenders perform a detailed analysis of all escrow accounts annually, to verify that the amount in escrow is in compliance with the law. This normally happens around the time the loan was originated. The lender computes the anticipated expenses for the coming year based on the costs from the preceding year. The lender then divides the resulting figure by 12 to determine the escrow payment amount to add to the homeowner’s loan payments for the coming year.
A lender may add a small cushion amount to the amount of the escrow payment, to cover any changes in costs for the upcoming year or other escrow shortages. The total cushion in the account cannot be more than one-sixth of the anticipated required escrow amount. RESPA allows the lender to add one-twelfth of the total allowable cushion to each escrow payment as a means of creating and maintaining the cushion.
If analysis shows that the escrow account holds more than the allowable one-sixth cushion, RESPA dictates that the overage must be dealt with immediately. If the amount is less than $50, the lender can either apply the money to the coming year’s escrow account or refund it to the homeowner. If the amount is $50 or more, the homeowner gets it in the form of an escrow refund.
Homeowners who feel that their escrow account is being mismanaged, such as payments not being made on time or too large of a cushion being held, must submit a complaint to the lender in writing detailing their concerns. HUD advises that this request should not be included with the mortgage payment, but sent to the lender separately. HUD allows the lender 20 business days to respond and 60 business days to arrive at a resolution.