Esoteric Escrows

Sorting the arcane Regulation X factor in new escrow requirements

By Mary Thorson and Kris Welch

The Dodd-Frank Wall Street Reform Act authorized the transfer of rulemaking responsibility for many consumer financial protection regulations to the Consumer Financial Protection Bureau, including the transfer of Regulation X and the Real Estate Settlement Procedures Act. In December 2011, the CFPB published its renumbered regulations, and the renumbering reflects the codification of its regulations in Title 12 (Banks and Banking), Chapter X (Bureau of Consumer Financial Protection) of the Code of Federal Regulation.

Regulation X sets out the requirements for an escrow account established in connection with a federally related mortgage loan. It sets limits for escrow accounts using calculations based on monthly payments and disbursements within a calendar year. Due to the escrow rules, it is even more important to review your bank’s escrow compliance, including its understanding of escrow accounting methods, how it prepares escrow disclosure statements and determines escrow deposit amounts, and how it ensures its annual escrow analysis results in correct account balances.

Three key components comprise escrow account management:

1. Escrow analysis at creation of the escrow account. Escrow tasks must be conducted in accordance with the accounting rules outlined in Regulation X. The regulation contains rules and limitations with regard to the amounts that may be held in escrow accounts as well as specific requirements for the contents of the initial and annual statements.

Of particular note is the requirement that lenders conduct an aggregate analysis, rather than a single-item analysis, when conducting the account analysis. A single-item analysis accounts for each escrow item separately, while an aggregate analysis considers the account as a whole when computing whether escrow account funds are sufficient.

Compliance with aggregate accounting rules is necessary to accurately calculate the required escrow amounts. Creditors must ensure their mortgage staff is adequately trained on the difference between single-item and aggregate analysis and when the different analyses can or must be used. If an automated system is used to conduct escrow analysis, it must be tested to ensure it can be relied upon to perform the required calcu­lations correctly.

Errors in the initial analysis may lead to incorrect initial escrow account statements. Errors on these statements may occur because of discrepancies between the escrow analysis and the initial escrow disclosure statement or amounts on the HUD-1 settlement statement. Some of the common errors include:

– failing to include flood insurance premiums in required escrow accounts;

– disclosing amounts on the initial escrow statement that are different from those amounts collected at closing for the initial escrow deposit;

– collecting lesser amounts of individual escrow line items to reduce the amount of the aggregate adjustments on the HUD-1; and

– failing to disclose the aggregate adjustment on the HUD-1.

Errors in the initial analysis may cause overcharging in the collection of the initial escrow deposits. Overcharging may result from:

– using incorrect cushion amounts in excess of the regulatory limitations;

– collecting excess funds when
– a property tax installment is paid
– at settlement;

– including mortgage insurance premiums in cushion amounts when they are paid monthly; or

– rounding adjustments to create an even dollar amount.

2. Charges and disbursements during the life of the escrow account. Throughout the life of an escrow account, a servicer may charge the borrower a monthly sum equal to one-twelfth of the total annual escrow payments that the servicer reasonably anticipates paying from the account. In addition, a servicer may add an amount to maintain a cushion no greater than one-sixth of the estimated total annual payments from the account. However, if a servicer determines through an escrow account analysis that there is a shortage or deficiency, the servicer may require the borrower to pay additional deposits to make up the shortage or eliminate the deficiency.

3. Subsequent escrow account analysis and the annual escrow account statement. Errors in the annual account analysis calculations may lead to surplus, shortage or deficiency amounts in the escrow account. Some typical causes include:

– using incorrect disbursement dates in projecting activity for the next year (e.g., changing the dates of projected disbursements can result in incorrect account balance projections);

– projecting surpluses, shortages or deficiencies based on incorrect account balances;

– maintaining incorrect cushion amounts in excess of regulatory requirements or lower limitations placed in mortgage loan documents; or

– failing to refund borrower(s) surplus amounts in excess of $50.

Incorrect annual escrow statements generally result from missing information, such as not including all the required elements, or from errors in the annual analysis. Examples of information that is often missing or incorrect on the annual statement include:

– the reason the projected low balance (i.e., cushion) was not reached;

– the total amounts paid into and out of the escrow account in the previous year; or

– one or more estimated payments or disbursements missing from the account analysis.

Reg X best practices

If your community bank offers escrow accounts, review its escrow accounting systems and disclosures to ensure compliance with the requirements of Regulation X. Lenders holding or servicing loans with escrow accounts should also consider the following best practices:

– Understand the differences between single-item and aggregate analyses. This distinction is a key factor in complying with the escrow accounting requirements.

– Conduct regular staff training on escrow requirements. Include training on the proper usage of the software platform used to generate escrow account disclosures.

– Perform periodic system testing to ensure systems are accurately performing escrow account analyses.

– Review mortgage loan documents for wording regarding cushion limits, and ensure that systems comply with either the regulatory or the contractual cushion limitations, whichever are lower.

– Develop policies and procedures for escrow account requirements.

– Conduct periodic compliance reviews and audits that include escrow accounting and the sufficiency of escrow account statements.


Mary Thorson is a vice president with Chartwell Compliance.

Kris Welch is a vice president with Chartwell Compliance.