# Amendments to Real Estate Settlement Procedures Act Regulation (Regulation X)Escrow Accounting Procedures

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URL: https://www.frixlaw.com/law-library/documents/fr%3A98-1395

## Record

- **Collection:** Federal Register
- **Document type:** Rule
- **Published:** January 21, 1998
- **Citation:** 63 FR 3214

## Text

SUMMARY: In this final rule, the Department of Housing and Urban
Development is revising Regulation X, which implements the Real Estate
Settlement Procedures Act of 1974 (RESPA). This rule addresses problems
that were raised in applying escrow accounting requirements under
Regulation X. The first problem, designated as ``Annual vs. Installment
Disbursements,'' involves whether disbursements from mortgage escrow
accounts must be made on an annual or installment basis when the payee
offers a choice. To address this problem, this rule maintains the
current requirements under Regulation X, but clarifies them.
The second problem, designated as ``Payment Shock,'' involves the
proper accounting method to calculate escrow payments where the
servicer anticipates that disbursements for items such as property
taxes will increase substantially in the second year of the escrow
account and where ``payment shock''--the consumer's experiencing of a
substantial rise in escrow payments--will result. The Department has
chosen to address this matter by recommending (but not mandating) a
best practice for servicers: a voluntary agreement to accept
overpayments. A consumer disclosure format has been provided to
disclose this information. This rule contains a new provision covering
procedures for voluntary overpayments.
The Department has determined not to adopt two other changes that
were proposed. The Department will continue to require the single-item
listing of escrow deposits on the HUD-1 or HUD-1A. Also, the Department
is not revising the requirements for listing a lead-based paint
inspection or risk assessment on the Good Faith Estimate (GFE) format
and HUD-1 and HUD-1A, but is clarifying the instructions for these
formats.

EFFECTIVE DATE: February 20, 1998.

FOR FURTHER INFORMATION CONTACT: David R. Williamson, Director, Office
of Consumer and Regulatory Affairs, Room 9146, or Rebecca J. Holtz,
Director, RESPA/ILS Division, telephone (202) 708-4560; or, for legal
questions, Kenneth A. Markison, Assistant General Counsel for GSE/
RESPA, Room 9262, telephone (202) 708-1550, or Grant Mitchell, Senior
Attorney for RESPA, telephone (202) 708-1552 (these are not toll-free
telephone numbers). For hearing-and speech-impaired persons, these
telephone numbers may be accessed via TTY (text telephone) by calling
the Federal Information Relay Service at (800) 877-8339 (toll-free).
The address for these persons is: Department of Housing and Urban
Development, 451 Seventh Street, SW, Washington, DC 20410-0500.

SUPPLEMENTARY INFORMATION:

I. Background

The Department's 1994-1995 escrow accounting rules 1
included significant new requirements for servicers maintaining an
estimated 35 million mortgage escrow accounts for American homeowners.
These rules, promulgated under the Real Estate Settlement Procedures
Act (RESPA) (12 U.S.C. 2601-2617), as amendments to Regulation X (24
CFR part 3500), limited the amounts that servicers may hold in escrow
accounts by establishing new uniform accounting and disbursement
requirements and by requiring meaningful disclosure to each homeowner
at the account's inception and annually thereafter.
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\1\ The Department issued several escrow rules during 1994-1995.
On October 26, 1994 (59 FR 53890), the Department published a final
rule implementing sections 6(g) and 10 of RESPA and changes to RESPA
made in section 942 of the Cranston-Gonzalez National Affordable
Housing Act (Pub. L. 101-625, approved November 28, 1990). Because
of the magnitude of the change brought about by this rule, soon
after its publication it became evident that further clarification
of the rule was needed. The Department issued a February 15, 1995
rule (60 FR 8812) that modified and clarified the October 1994 rule
and delayed its effective date until May 24, 1995. The Department
issued further rules to clarify and correct the October 1994 rule on
December 19, 1994 (50 FR 65442); March 1, 1995 (60 FR 11194); and
May 9, 1995 (60 FR 24734), and published a notice of software
availability on April 4, 1995 (60 FR 16985). These rules are
referred to in this preamble collectively as the 1994-1995 escrow
rules.
The Department's RESPA regulations were streamlined on March 26,
1996 (61 FR 13232) to comply with the President's regulatory reform
initiatives. On September 3, 1996 (61 FR 46510), the Department
published a correction to 24 CFR 3500.17. The Department published
further revisions to Regulation X on September 24, 1996 (61 FR
50208) and November 15, 1996 (61 FR 58472).
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The 1994-1995 escrow rules represented a notable achievement. As a
result of the escrow rules, the amounts in homeowners' escrow accounts
have been reduced substantially. At the time the rules were
promulgated, the Department estimated that homeowners would save as
much as $1.5 billion by virtue of the new rules. This savings is now
being used by homeowners for down payments, to keep and maintain homes,
or to fill other needs.
Because the 1994-1995 escrow rules implemented new accounting
requirements, they required major changes by mortgage servicers. As the
rule's requirements were applied to individual accounts, members of
Congress, local government officials, industry representatives, and
homeowners brought to the Department's attention certain problems
concerning the 1994-1995 rules. In this final rule, the Department is
clarifying the rules and identifying ``best practices'' 2 of
mortgage servicers in an effort to resolve two of these problems.
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\2\ Generally, the Department has characterized ``best
practices'' in other programs as those practices that are in
accordance with a law's purposes, that are widely replicable, that
show creativity in addressing a problem or problems, and that have a
significant positive impact on those whom they are intended to
serve. The Department identifies best practices operating
successfully in the marketplace that support the regulatory
principles involved in order to encourage their use. For example,
the Department has identified best practices in furtherance of its
responsibilities under the Fair Housing Act (42 U.S.C. 3601 et
seq.).
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As detailed below, the first problem, designated as ``Annual vs.
Installment Disbursements,'' is whether disbursements from mortgage
escrow accounts should be made on an annual or installment basis if the
payee offers a choice. In some cases, a switch from installment to
annual disbursements, required under certain circumstances under the
rule, resulted in servicers requiring greater payments to escrow
accounts for some borrowers and adverse tax consequences for some
borrowers. The second problem, designated as ``Payment Shock,'' was
asserted to occur when borrowers were required to make significantly
increased payments into their escrow accounts when disbursements for
items such as property taxes would increase substantially in the second
year of the escrow account and the rule did not allow servicers to
require escrowing for the next year's payments. The Department also
became aware of two additional concerns involving the disclosure of
amounts required for escrow using single-item accounting and involving
the possible need for a new disclosure of lead-based paint inspection
fees.
All of these matters led the Department to issue a proposed rule on
September 3, 1996 (61 FR 46511) to seek public comment on these issues.
In the

[[Page 3215]]

proposed rule, the Department offered a variety of approaches to
address these matters in the most economical and efficient way. The
Department recognized that the rules were new and industry and consumer
adjustments were underway. Consequently, the choices included keeping
the requirements the same, but clarifying them, or doing nothing.
In the Department's proposal, the Secretary pointed out that any
amendments to the rule must further the following three principles:
(1) Reduce the cost of homeownership by ensuring that funds are not
held in escrow accounts in excess of the amounts that are necessary to
pay expenses for the mortgaged property and allowed by law;
(2) Establish reasonable, uniform practices for escrow accounting;
and
(3) Provide servicers with clear, specific guidance on the
requirements of section 10 of the Real Estate Settlement Procedures Act
of 1974 (RESPA), which governs escrow accounting procedures.
Following receipt of comments under the proposed rule, as detailed
below, the Department determined that many of the initial problems in
implementing the escrow rules were being resolved as the industry and
the public adjusted to the new requirements. Specifically with respect
to the choice of annual vs. installment disbursements, consumers'
accounts that had been changed as a result of the implementation of the
rule had stabilized and had not been changed again. However, there
remains a need for the Department to clarify and elucidate current
requirements in this final rule.
With regard to the ``payment shock'' problem, the Department
determined, based on the comments, that extensive additional regulatory
changes are not required and could prove detrimental to consumers.
Instead, the Department determined that this problem would be better
resolved by identifying and sharing best practices of servicers. In
this context, servicers should, as a best practice, provide a simple
notice to consumers to allow them voluntarily to increase their
payments to their accounts. A new provision in 24 CFR
3500.17(f)(2)(iii) sets forth procedures if voluntary overpayment
agreements are obtained.
The Department also determined not to adopt other changes to the
Good Faith Estimate (GFE), HUD-1, and HUD-1A that were proposed to
address the other matters raised in the proposed rule. Based on the
comments received, the Department determined that new requirements on
these subjects were not necessary. Current disclosure requirements are
generally useful and sufficient; more significant changes at this time
could serve to confuse matters while the market is still adjusting to
the relatively new rules. Moreover, the Department has recently issued
a new settlement booklet for consumers entitled ``Buying Your Home,
Settlement Costs and Helpful Information,'' published on June 11, 1997
(62 FR 31982), which includes guidance on lead inspections during the
homebuying process. To complement these new materials, the Department
is making one minor clarification to the instructions for the HUD-1
regarding lead-based paint disclosures.
In sum, the regulatory record, described in detail below, makes
very clear that this subject involves complex matters that in many
cases are better resolved by allowing time for accounting systems and
consumers alike to adjust. In this final rule, the Department continues
to protect homeowners by maintaining escrow accounting requirements and
limits without change. At the same time, in the interest of reducing
homeownership costs, establishing uniform practices, and providing
clear specific guidance, the rule makes modest clarifications to ensure
that servicers do not unnecessarily incur additional costs that would
ultimately be passed on to American homeowners.
In applying the significant protections under RESPA--including the
limits on the amounts in mortgage escrow accounts--the Department is
mindful that it must carry out RESPA's important requirements in a
manner that is true to RESPA's consumer protection purposes. These
purposes include ensuring that consumers are protected from
unnecessarily high costs that may come from abusive practices by
servicers.
This preamble continues with a background discussion of the legal
requirements under section 10 of RESPA and the Department's prior
rulemakings. Following the background discussion, the preamble
discusses the issues addressed in the proposed rule and details the
many comments received on the proposed rule. These comments informed
the Department and shaped today's rule. Finally, the preamble discusses
this final rule.

II. Legal Context

Section 10 of RESPA (12 U.S.C. 2609) establishes the statutory
limits on the amounts that mortgage servicers or lenders may require a
borrower to deposit into an escrow account if the mortgage documents
require one or the servicer chooses to establish one.3 RESPA
does not require the use of escrow accounts. Section 10(a)(1) of RESPA
does prohibit a servicer, at the time the escrow account is created,
from requiring the borrower to make a payment to the escrow account in
excess of the maximum amounts calculated in accordance with the
statute. These maximum amounts are calculated by analyzing how much
money will be needed to cover expected disbursements, such as taxes and
insurance, ``beginning on the last date on which each such charge would
have been paid under the normal lending practice of the lender and
local custom, provided that the selection of each such date constitutes
prudent lending practice, and ending on the due date of the first full
installment payment under the mortgage'' relating to the mortgaged
property, plus a cushion no greater than one-sixth of the estimated
total annual disbursements from the account (one-sixth cushion).
Section 10(a)(2) prohibits the lender, over the rest of the life of the
escrow account, from requiring the borrower to make payments to the
escrow account that exceed one-twelfth of the total annual escrow
disbursements that the lender reasonably anticipates paying from the
escrow account during the year, plus the amount necessary to maintain a
one-sixth cushion. Section 10 does not require that the servicer
collect the maximums allowed under the statute; the servicer may always
collect less and is not required to collect any cushion at all.
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\3\ As stated in footnote 1 to the preamble to the Department's
September 3, 1996 proposed rule on escrow accounting (61 FR 46511,
46511 n.1), at times RESPA uses the term ``lender'' and at other
times it uses the term ``servicer.'' A lender creates a loan
obligation, but may or may not service the loan. As in the proposed
rule, within this final rule the Department uses the term
``servicer'' to include the lender when the lender performs the
servicing function.
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Section 10 and section 6(g) of RESPA (12 U.S.C. 2605(g)) govern the
timing of disbursements from escrow accounts. In choosing a
disbursement date, section 10 requires that the servicer follow
``normal lending practices of the lender and local custom, provided
that the selection of each such date constitutes prudent lending
practice.'' Section 6(g) requires servicers to ``make payments from the
escrow account for such taxes, insurance premiums, and other charges in
a timely manner as such payments become due.''

[[Page 3216]]

III. Explanation of Problems Addressed in September 3, 1996
Proposed Rule and Proposed Solutions

On September 3, 1996 (61 FR 46511), the Department published a
proposed rule, primarily to address three problems in implementing the
1994-1995 escrow rules. These problems, explained below, were
designated as:
Annual vs. Installment Disbursements;
Payment Shock; and
Single-item Analysis with Aggregate Adjustment.
In addition, the Department proposed revising the GFE format and
HUD-1 and HUD-1A to refer specifically to a lead-based paint inspection
or risk assessment.

A. Annual vs. Installment Disbursements Problem

1. Explanation of the Annual vs. Installment Disbursements Problem
The first problem that the proposed rule addressed involved the
servicers' disbursements from mortgage escrow accounts if the payee
(i.e., the entity to which escrow disbursements are paid, such as a
taxing jurisdiction) offers a choice of disbursements on an annual or
installment basis. Sometimes payees offer a discount to the borrower if
disbursements are made on an annual basis. These discounts are commonly
offered by taxing jurisdictions, which may offer a discount for annual
payments of property taxes.
The Department's regulation at 24 CFR 3500.17(k)(1) has provided,
``In calculating the disbursement date, the servicer shall use a date
on or before the earlier of the deadline to take advantage of
discounts, if available, or the deadline to avoid a penalty.'' See also
Secs. 3500.17(b) (definition of ``disbursement date''); 3500.17(c)(2)
and (c)(3); and 3500.17(d)(1)(i)(A) and (2)(i)(A). The preamble to the
October 1994 final rule explained, ``Unless there is a discount to the
borrower for early payments, the regulation does not allow servicers to
pay installment payments on an annual or other prepayment basis.'' 59
FR 53893. The preamble explained that this approach is consistent with
the Department's intention that the regulations generally favor
installment disbursements, because in many cases they result in lower
up-front payments (closing costs). The Department also sought for
servicers to take advantage of discounts that would benefit borrowers.
In response to further questions on this issue, however, the
Department indicated in its February 1995 final rule clarifying the
escrow rules that the October 1994 rule's focus had been to address ``a
practice, previously engaged in by some servicers, of collecting and
paying a full-year's taxes in advance, although they were billed on an
installment basis.'' 59 FR 8813. In the preamble to a May 1995 further
clarification to the rules, the Department stated that ``servicers were
permitted (but not required) to make disbursements on an annual basis
if a discount were available.'' The preamble to the May 1995 rule
explained:

[T]he Department received a number of questions regarding
circumstances in which the payee offered an option of either
installment payments or a one-time payment with a discount. The
preamble to the October 26, 1994, and February 15, 1995, rules
indicated that when a choice was available, servicers should make
disbursements on an installment basis, rather than an annual basis;
however, servicers were permitted (but not required) to make
disbursements on an annual basis if a discount were available. Once
the choice of payment basis is made, the disbursement date chosen
for that basis depends on discount and penalty dates. Section
3500.17(k) states that ``[i]n calculating the disbursement date, the
servicer shall use a date on or before the earlier of the deadline
to take advantage of discounts, if available, or the deadline to
avoid a penalty.'' This provision is consistent with the rule, which
is designed to avoid excessive upfront payments and balances in
escrow accounts and, therefore, favors installment payments, unless
there are penalties or discounts that make annual payments
advantageous for the consumer. Also, after settlement a servicer and
borrower are not prevented by this rule from mutually agreeing, on
an individual case basis, to a different payment basis (installment
or annual) or disbursement date.

60 FR 24734.
In the preamble to the September 3, 1996 proposed rule, the
Department indicated that the rule text and the preamble language may
have created confusion. As explained in the preamble to the proposed
rule, some mortgage servicers have interpreted the rule to require that
a servicer, when offered an option of making a disbursement from the
escrow account in installments or in an annual disbursement with a
discount, must choose the lump sum annual disbursement with a discount,
no matter how small the discount is, even if the borrower and the
servicer would otherwise agree to forego the discount and have the
escrow account computed for disbursements on an installment basis. On
the other hand, other servicers have interpreted the Department's rule,
in light of preamble language, to require installments when available
and allow, but not require, annual disbursement at the servicer's
discretion when a discount is offered for annual disbursement.
As indicated in the preamble to the proposed rule, some borrowers
were affected by the changes brought about by the 1994-1995 escrow
rules. Concerns raised to the Department regarding the annual vs.
installment disbursements problem came from borrowers and members of
Congress who were concerned about the effect of the 1994-1995 escrow
rules on their constituents.
As explained in the preamble to the proposed rule, the choice of
disbursement methods has consequences for borrowers, including
increasing or decreasing the amounts required to be deposited into the
escrow account at closing. In general, disbursements from an escrow
account in installments work to the borrower's benefit, because, on
average, they result in lower up-front payments to establish the
account (i.e., lower closing costs). Footnote 2 of the proposed rule
(61 FR 46512) explained:

The choice of installment, rather than annual, disbursements
often results in substantial reductions in up-front cash
requirements for the buyer. For example, if two equal installments
could be paid 6 months apart instead of paying the entire bill on
one of the installment dates, then homebuyers who close on their
loans less than 6 months before the date on which the entire bill
would otherwise have been due could come to settlement with 6 months
less in tax deposits to the escrow account. This results from the
accrued taxes being a half-year's taxes less for those homebuyers.
Assuming closings are evenly distributed throughout the year,
households with the option of two equal installment payments 6
months apart, will, on average, be able to reduce the average up-
front cash required at settlement by 3-months' worth of taxes. In
general, as the number of installments grows, so does the average
up-front savings.

The disbursement method may also have income tax ramifications for the
consumer, depending on the timing of disbursements for deductible
items.
The preamble to the proposed rule explained that after publication
of the 1994-1995 escrow rules, many servicers that had been disbursing
in installments switched to annual disbursements if discounts were
available. There were many consequences of the switch that have been
described to the Department, mostly affecting borrowers, and other
consequences that the Department speculates may have resulted. After
the Department issued the escrow rule, some borrowers may have been
required by their servicers to make up substantial shortages in their
escrow accounts (generally in increased monthly payments over a year),
which arose

[[Page 3217]]

when taxes were switched from installment disbursements to one annual
lump sum disbursement.
The preamble to the proposed rule also noted other adverse
consequences that might have arisen from the 1994-1995 escrow rules.
For example, some borrowers whose servicers switched from annual to
installment disbursements may have lost a significant portion of their
income tax deductions for property taxes in the year in which the
switch was made and may have been unhappy with that consequence. Some
taxing jurisdictions may have faced an unexpected temporary shortfall
in receipts of property taxes as a result of servicers changing from
annual to installment disbursements.
The preamble to the proposed rule also noted that although some
borrowers may have been adversely affected by a change in disbursement
method, many others likely benefited, perhaps unknowingly, from such a
change. For example, a change from installment to annual disbursements
to take advantage of a discount lowered the total tax burden for many
homeowners. Similarly, a change from annual to installment
disbursements resulted in lower escrow payments and, possibly, refunds
or credits for many homeowners. Finally, for many borrowers, the
Department's rules apparently have not resulted in any change to the
disbursement method for their escrow accounts.
2. Alternatives Proposed to Address Annual vs. Installment
Disbursements Problem
In response to the Annual vs. Installment Disbursements problem,
the Department proposed alternative ways of revising the escrow rules,
including requiring that disclosures be given to borrowers so that they
could make informed choices as to how their accounts were to be set up
and maintained and require servicers to follow those preferences. At
the same time, the Department recognized that providing borrowers
choices may impose additional burdens and costs on servicers, which are
frequently passed on to borrowers. Thus, the proposed rule also
highlighted approaches that had been proposed by industry
representatives. The Department sought comments on all approaches and
also asked a number of questions that were designed to help the
Department make decisions among alternatives for the final rule.
a. Consumer Choice. The first alternative contained in the proposed
rule, Consumer Choice, distinguished between new loans and existing
loans. Under this alternative, for new loans (loans that settled on or
after the effective date of a final rule), servicers would be required
to give borrowers the choice of making disbursements of property taxes
on an installment or on an annual basis, when those options are offered
by the taxing jurisdiction. The Department's proposal did not address
the choice between installments and annual disbursements for other
escrow items, because the question has only been raised to the
Department in the context of property taxes. The preamble indicated
that the Department would consider addressing other escrow items,
depending on comments received.4
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\4\ The preamble to the proposed rule noted that if the servicer
is given a choice between installment or annual disbursements for
other escrow items (such as property or hazard insurance), the
Department's rule would require the servicer to make disbursements
by a date that avoids a penalty, but the servicer would otherwise be
free to make disbursements on such date as complies with normal
lending practice of the lender and local custom, provided that the
selection of each such date constitutes prudent lending practice.
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This alternative would have required servicers, at some time before
settlement, to provide a disclosure, in the format of Appendix F in the
proposed rule, to borrowers whose property taxes will be paid from an
escrow account and whose taxing jurisdictions offer the choice between
disbursements on an installment or an annual basis. The proposed format
indicated some of the advantages and disadvantages to the borrower of
installment and annual disbursements and asked the borrower to make a
choice between the methods. The preamble explained that if the borrower
did not make a choice, the servicer would be required to make
installment disbursements of property taxes. As discussed below, this
alternative also would have provided that once the consumer had made a
choice (or installments were required because the consumer did not make
a choice), the servicer and subsequent servicers would be prohibited
from changing the method of disbursement for property taxes without the
borrower's prior written consent, as long as the taxing jurisdiction
continued to offer a choice.
For existing loans (loans that were settled prior to the effective
date of a final rule), this alternative would have prohibited the
servicer and subsequent servicers from changing the method of
disbursement for property taxes without the borrower's prior written
consent where the taxing jurisdiction offers a choice between
installments and annual disbursements. In addition, no later than the
first escrow analysis for such escrow accounts performed after the
effective date of a final rule, servicers would be required to offer
borrowers, in writing, an opportunity to switch from one method of
disbursement for property taxes to another.
b. Servicer Flexibility. Under the second alternative presented in
the proposed rule, the Department would have revised the rule to
provide that a servicer must make disbursements by a date that avoids a
penalty, but the servicer is otherwise free to make disbursements on
such date as complies with normal lending practice of the lender and
local custom, provided that the selection of each such date constitutes
prudent lending practice. As discussed below, under this alternative,
once the servicer had made a choice of the disbursement method, the
servicer and subsequent servicers would have been prohibited from
changing the method of disbursement without the borrower's prior
written consent, as long as the payee continued to offer a choice.
c. Keep, But Clarify, Current Requirements. The third alternative
offered in the proposed rule was that the Department would revise the
rule to keep, but clarify the current requirements. Under this
alternative, the regulations would have been revised to provide that
servicers must make disbursements from escrow accounts on an
installment basis, if payees offer that option as an alternative to
annual disbursements. If a payee offers the option of installment
disbursements or a discount for annual disbursements, however, the
servicer may, at the servicer's discretion (but is not required by
RESPA to), make annual disbursements, in order to take advantage of the
discount for the borrower; the Department encourages (but does not
require) servicers to follow the preference of the borrower. If the
payee offers the option of installment disbursements or annual
disbursements with no discount, the servicer must make installment
disbursements.
d. Prohibition Against Switching Disbursement Methods Without
Borrower's Consent. Each of the alternatives proposed--Consumer Choice;
Servicer Flexibility; and Keep, But Clarify, Current Requirements--
provided that once a disbursement method has been selected in
accordance with the requirements of the alternative, servicers would be
prohibited from switching disbursement methods without the borrower's
consent. This would mean that even if one servicer acquires servicing
from another servicer, the second servicer would be required to apply
the same disbursement method as the first servicer, as long as that

[[Page 3218]]

option is offered by the payee, unless the borrower consents to
changing disbursement methods.
The preamble to the proposed rule explained that the reason for
this approach was that many loans shifted disbursement dates as a
result of the 1994-1995 escrow rules. The Department was seeking to
develop an approach with the minimum negative impact for borrowers,
servicers, and third parties, such as taxing jurisdictions.
The preamble to the proposed rule explained the adverse
consequences, discussed above, that can occur when borrowers'
disbursement methods are switched. The preamble to the proposed rule
explained that the approach of prohibiting a servicer from switching
disbursement methods without the borrower's consent, including
requiring a servicer to use the disbursement method used by the former
servicer when there is a transfer of servicing, would not mean that the
borrower would have to consent to a transfer of servicing or would have
veto authority over such a transfer. However, this approach would mean
that a borrower would have to consent to a change in the disbursement
method, including a change proposed by a subsequent servicer. The
Department sought comments on whether this policy would adversely
affect the value, and the efficiency of the transfer, of servicing
rights.

B. Payment Shock Problem

1. Explanation of Payment Shock Problem
The second problem that the proposed rule addressed involved cases
in which the originator or servicer 5 anticipates that
disbursements for escrow items such as property taxes will increase
substantially in the second year of the escrow account. A substantial
increase in property taxes in the second year often occurs in cases of
new construction. In many jurisdictions, the taxes the locality charges
for the first year are based on the assessed value of the unimproved
property, while for the second year the taxes are based on the improved
value. A substantial increase in payments may also occur when a tax
disbursement that would normally appear on the projection for the
coming year is paid prior to the borrower's first regular payment,
i.e., these regularly occurring taxes do not appear in the projection.
Reassessments after a property is sold may also cause a substantial
second year increase.
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\5\ Three originators/servicers criticized the Department's
proposed rule because it identified the ``servicer'' as the person
who would be in a position to determine whether the bills paid out
of the escrow account will increase substantially after the first
year. These commenters indicated that it is the originator (loan
officer, processor, settlement agent) who communicates with
borrowers prior to closing, not the servicer, and that it should be
the originators who would be in the position of determining at
closing whether payments will substantially increase, not the
servicer. The Department intended to use the terms interchangeably
and explained in footnote 1 of the proposed rule (61 FR 46511) that
the term ``servicer'' included the lender when the lender performs
the servicing functions. The Department intended that the term
``servicer'' also would include the originator in this context.
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The preamble to the proposed rule explained that, consistent with
section 10 of RESPA, the Department's regulations have specified the
maximum amount that a servicer may legally require borrowers to deposit
in escrow accounts at the creation of the escrow account and during the
life of the escrow account. The Department's regulations prescribe that
in conducting an escrow account analysis, the servicer considers only
the disbursements that are expected to come due during the next 12-
month period. See Secs. 3500.17(b) (definition of ``escrow account
computation year'') and 3500.17(c) (limits on payments to escrow
accounts). While the servicer can take into account expected changes to
disbursements over the 12-month period,6 even if the
servicer knows that disbursements from an escrow account will
substantially increase at a time more than 12 months in the future, the
servicer cannot, when preparing the initial escrow account statement,
calculate the borrower's payments to cover the expected increases
beyond that 12-month period.
---------------------------------------------------------------------------

\6\ The preamble to the proposed rule (61 FR 46511, 46516 n.7)
explained that the Department's current regulations address the
issue of estimating disbursement amounts for the 12-month
computation year:
To conduct an escrow account analysis, the servicer shall
estimate the amount of escrow account items to be disbursed. If the
servicer knows the charge for an escrow item in the next computation
year, then the servicer shall use that amount in estimating
disbursement amounts. If the charge is unknown to the servicer, the
servicer may base the estimate on the preceding year's charge as
modified by an amount not exceeding the most recent year's change in
the national Consumer Price Index for all urban consumers (CPI, all
items). In cases of unassessed new construction, the servicer may
base an estimate on the assessment of comparable residential
property in the market area.
24 CFR 3500.17(c)(7).
---------------------------------------------------------------------------

However, the Department's existing regulations
(Sec. 3500.17(f)(1)(ii)) allow the servicer to conduct escrow account
analyses at other times during the escrow computation year, which can
result in changes to what the borrower must deposit in the escrow
account. Some servicers conduct escrow account analyses when bills for
escrow items increase.
Since the Department's current escrow rule provides for calculating
escrow payments based on the projection of escrow disbursements for a
12-month period, when escrow items increase substantially after the
initial 12-month period, the result is likely to be a substantial
increase in a borrower's monthly payments for the second year and/or a
lump sum payment, not only to reflect the higher disbursements, but to
make up a shortage in the escrow account.7 While the
originator or servicer could alert the borrower at closing that an
increase will occur, if that is not done, the borrower may be
unpleasantly surprised by the increase. The preamble to the proposed
rule explained that this situation could result in several problems.
While disclosures received at closing show low payment amounts
throughout the first year, the escrow payment will substantially
increase for the second year, or even during the first year if a short-
year statement is issued at the point when the higher disbursement
shows up in the 12-month projection.8 Some borrowers may be
unable to meet the increased escrow payments and paying off the
shortage will raise payments even more. A customer relations issue may
be created for servicers who have to explain to borrowers why the
payment is increased so much.
---------------------------------------------------------------------------

\7\ The preamble to the proposed rule explained that an increase
in the monthly payment can be broken down into two components. Any
time an escrow account disbursement increases, it will have the
effect of raising the monthly borrower escrow payment by
approximately one-twelfth of that increase. In addition, the
projection for the coming year shows what the target balance
(accruals plus the cushion) should be at the beginning of the coming
year. To the extent that expected disbursements in the second year
exceed what they were in the first, the beginning target balance for
the second year may be in excess of the actual balance at the end of
the first year. If so, then there is a shortage to be made up as
well. If the 12-month approach is taken to eliminate the shortage,
then monthly payments will also rise by approximately one-twelfth of
the shortage. If a cushion is used, the payment increases will be
slightly higher, until the cushion is built up.
\8\ The Department's regulations at 24 CFR 3500.17(f)(1) (i) and
(ii) provide that, aside from conducting an escrow account analysis
when an escrow account is established and at completion of the
escrow account computation year, a servicer may conduct an escrow
account analysis at other times. The escrow account analyses
conducted at other times result in short-year statements.
---------------------------------------------------------------------------

As indicated in the preamble to the proposed rule, the concerns
raised to the Department regarding payment shock came largely from
industry representatives who told the Department that they have had to
respond to numerous borrower inquiries

[[Page 3219]]

and complaints about increases in escrow payments to reflect higher
disbursements and payments to make up shortages. Mortgage servicers had
indicated that they wanted to avoid any payment change in subsequent
years by collecting more money in the first year of servicing.
2. Alternatives Proposed to Address Payment Shock Problem
The proposed rule offered three rulemaking alternatives, some of
which contained variations within the alternative, to address the
payment shock problem. The purpose of the alternatives was to develop a
consumer-friendly way to avoid the payment shock surprise for the
borrower, who may not be prepared to make the higher payments to his or
her escrow account that would result from a substantial increase in the
amounts needed for disbursements from the account. At the same time,
the proposals sought to minimize the burden on the industry.
a. Consumer Choice. The first alternative contained in the
proposed rule, Consumer Choice, would have provided that when the
servicer expected that the bills disbursed from the escrow account
would increase substantially after the first year, the servicer would
provide to the borrower, at some time prior to closing, a written
disclosure. The proposed format for the disclosure was set forth in
Appendix G to the proposed rule. The borrower would make a choice from
several accounting options for his or her account on a format that
would indicate, under each option: (1) the amount due at closing; (2)
the monthly escrow payments in the first, second, and third years; and
(3) the corresponding surpluses anticipated at the end of the first
year.9
---------------------------------------------------------------------------

\9\ The preamble to the proposed rule noted that whether
disbursements from escrow accounts would be made on an annual or
installment basis and whether there were a discount for annual
disbursement would affect the numbers to be filled in and,
potentially, the number of calculations on the Escrow Accounting
Method Selection Format.
---------------------------------------------------------------------------

The proposed rule explained that the borrower would, therefore,
have the opportunity to make a voluntary choice to limit payment
changes in the second year of the escrow account. As would be explained
on the disclosure format, if the borrower did not make a choice, the
accounting method would ``default'' to the method prescribed under the
current regulations (which may result in substantially increased
payments in the second year). This alternative, as proposed, contained
the additional restriction that once an escrow accounting method was
selected by choice or default, that method could not be changed without
the consent of the borrower, even if the servicing rights were
transferred to another servicer.
The preamble to the proposed rule explained that, under this
alternative, the following accounting methods (illustrated in ``The
Payment Shock Problem,'' Appendix H-1 to the proposed rule) would be
presented to the borrower for his or her selection:
Method A. Analysis of the account using the accounting method
required under the current rule, which results in a shortage at the end
of the first year and higher payments in the second year.
Method B. Analysis of the account using an accounting method that:

--Requires an initial deposit of $0 into the escrow account at closing;
--Requires a monthly payment in the first year equal to one-twelfth of
the estimated total annual disbursements from the escrow account for
the second year; and
--Causes surpluses or smaller shortages at the end of the first year,
which causes escrow payments to increase in the second year by an
amount less than under Method A or not at all.

Method C. Analysis of the account using an alternative accounting
method that:

--Requires an initial deposit into the escrow account at closing
greater than the initial deposits required under Method B;
--Requires the same monthly payment during the first year as under
Method B, which is greater than under Method A;
--Generates month-end balances such that the lowest month-end balance
for the first year equals one-sixth of the estimated total annual
disbursements for the second year (the initial deposit is not
considered in finding the lowest month-end balance);
--Generates even larger balances at the end of the first year than
under Method B, eliminating shortages and increasing surpluses that
must be returned to the borrower; and
--Causes no increase in escrow payments in the second year.

The preamble to the proposed rule noted that if the consumer were
to select Methods B or C, the amounts held in escrow could be greater
than allowed under section 10 of RESPA. In order to permit these
options, the Secretary would invoke his exemption authority under
section 19(a) of RESPA (12 U.S.C. 2617).
b. Make No Change. The second alternative in the proposed rule was
to continue the current requirements for escrow analysis, even when the
servicer expected that the bills disbursed from the escrow account
would increase substantially after the first year. This alternative
would not prevent payment shock in all instances. However, under this
alternative, servicers could continue to disclose voluntarily the
problem to borrowers and borrowers could make voluntary overpayments to
escrow accounts. Servicers could also calculate short-year statements.
Thus, even if no change were made to the regulations, some methods
would continue to be available, although not required, to alleviate the
payment shock problem.
c. Mandate First Year Overpayment. Under the third alternative in
the proposed rule, Mandate First Year Overpayment, the Department would
have provided that when the servicer expected that the bills disbursed
from the escrow account would increase substantially after the first
year, the servicer would be required to establish the escrow account
under a procedure that had the characteristics described under Consumer
Choice, Method C, above (illustrated in ``The Payment Shock Problem,''
Appendix H-2 to the proposed rule). The preamble to the proposed rule
explained that this approach would result in requiring amounts held in
escrow to be greater than allowed under section 10 of RESPA. The
Secretary could, however, mandate the use of this escrow accounting
method pursuant to his exemption authority under section 19(a) of RESPA
(12 U.S.C. 2617).

C. Single-Item Analysis With Aggregate Adjustment Problem

1. Explanation of Single-Item Analysis With Aggregate Adjustment
Problem
A third problem that the proposed rule addressed was the means of
disclosure on the HUD-1 and HUD-1A settlement forms of amounts required
for deposit at settlement in the escrow account. The 1994-1995 escrow
rules established aggregate accounting (i.e., analyzing the escrow
account as a whole) as the uniform nationwide standard escrow
accounting method to be used to compute borrowers' escrow accounts. In
establishing this standard, the rules supplanted single-item
accounting, the accounting method that had been used at settlement up
until that time to compute required escrow account balances.
Historically, under single-item accounting, the reserve amount for each
escrow account item on the HUD-1 or HUD-1A in the 1000 series was
computed for the borrower and listed separately. Either zero, one, or
two months worth of payments for

[[Page 3220]]

each escrow item was set forth on the HUD-1 or HUD-1A in the 1000
series as necessary to establish the escrow account.
When the Department was developing the 1994-1995 escrow rules,
Federal Reserve Board staff indicated that even if aggregate accounting
were used it also needed a single-item amount for private mortgage
insurance (PMI) reserves in order to make annual percentage rate (APR)
calculations under the Truth in Lending Act (TILA). For this reason,
and in an effort to avoid altering the basic format of the HUD-1 or
HUD-1A in the 1994-1995 escrow rules, the Department required that an
aggregate adjustment (either zero or a negative number) be made after
all of the individual items were listed separately in the 1000 series,
so that the total amount for escrow account items conformed to the
aggregate accounting method. Before the 1994-1995 escrow rules, Section
L of the HUD-1 and HUD-1A only showed positive numbers, that is,
payments that were being allocated to various settlement costs. After
publication of the 1994-1995 escrow rules, the Department received
complaints that the itemization of the reserve amounts with an
aggregate adjustment was confusing and the information was not useful
to borrowers. Settlement agents and others indicated that individual
itemization of reserves in the 1000 series imposed an additional
paperwork and explanation burden, when the only relevant number for
calculations is the total deposited.
2. Revision Proposed to Address Single-Item Analysis With Aggregate
Adjustment Problem
In response to the Single-Item Analysis with Aggregate Adjustment
problem the Department proposed to make more flexible the requirements
for the provision of information to consumers. In the proposed rule,
the Department proposed that to relieve confusion it would no longer
require the single-item listing of escrow deposits or reserves on the
HUD-1 or HUD-1A. The rule would create a new option in the instructions
for the 1000 series of these forms to reflect the aggregate amounts to
be deposited. As proposed, the settlement agent could also have
continued to itemize the 1000-series reserves, at the settlement
agent's discretion. If the charges were not itemized, an asterisk (*)
would have had to be placed next to each item in the 1000 series for
which a reserve was taken. The amount collected would have been
described as ``Aggregate Escrow Deposit for Items Marked (*) Above'' on
a line at the end of the 1000 series. In the discussion
``Clarifications of Existing Rule'' in Part VI of the preamble to the
proposed rule, the Department had clarified that entries on the GFE may
be based on single-item analysis, with a maximum 1-month cushion. The
proposed rule also clarified that the use of the estimating method
remained available after the end of the phase-in period (October 24,
1997).

D. Lead-Based Paint Disclosure Issue

1. Explanation of Lead-Based Paint Disclosure Issue
The proposed rule also addressed a concern that consumers should
get information about their right to arrange for a timely paint
inspection or risk assessment for the presence of lead-based paint or
lead-based paint hazards before becoming obligated under a sales
contract. The preamble to the proposed rule explained that a
prospective purchaser generally has 10 days to conduct such a lead-
based paint evaluation of the property. A prospective purchaser,
however, may waive in writing the opportunity to conduct this
evaluation. The proposed rule addressed ways that consumers could
receive this information in addition to existing disclosure
requirements.
2. Revision Proposed to Address Lead-Based Paint Disclosure Issue
In response to the Lead-based Paint Disclosure issue, the
Department proposed to require additional information to be provided to
the consumer on the GFE and the HUD-1 or HUD-1A. The Department
proposed to add information to the GFE format to help make purchasers
of pre-1978 residential dwellings aware that, pursuant to 42 U.S.C.
4852d (implemented by the Department in regulations published on March
6, 1996, 61 FR 9064), purchasers have the right to arrange for a paint
inspection or risk assessment for the presence of lead-based paint or
lead-based paint hazards before becoming obligated under a sales
contract. The Department proposed to add language to the GFE format
(Appendix C to part 3500) specifically to refer to a lead-based paint
inspection or risk assessment and designate a separate line in the 1300
series of the HUD-1 and HUD-1A for lead-based paint inspections or
assessments and to revise the instructions for completing the HUD-1 and
HUD-1A accordingly. The preamble to the proposed rule indicated that
the Department anticipated that a more detailed explanation of
purchasers' rights in this regard would be contained in the next
revision of the HUD Settlement Costs booklet. See section 5 of RESPA
(12 U.S.C. 2604); 24 CFR 3500.6.

IV. Overview of Public Comments

A. Description of the Commenters

The Department received a total of 141 comments on the proposed
rule. Of the 141 comments, some were duplicates. Thus, the Department
places the number of different comments received at 134.10
The Department analyzed all the comments in detail and gave them
careful consideration.
---------------------------------------------------------------------------

\10\ Seven comments were identical letters submitted by various
officials of the same mortgage corporation; they were counted as one
comment. Two other comments were substantially similar letters
submitted by different offices of the same bank and mortgage lending
subsidiary; they also were counted as one comment, but minor
variations between the two were considered.
Twenty-one comments were duplicate comments submitted by various
originators and servicers, including the United States Department of
Agriculture. One bank and trust submitted nearly identical comments
as the Mortgage Bankers of America (MBA), while the Oregon Bankers
Association submitted nearly identical comments as the American
Bankers Association (ABA). The Mortgage Bankers Association of
Minnesota adopted with one small addition the comments of Norwest.
Since these comments were submitted by separate entities, they are
all counted as separate comments.
One commenter simply summarized the proposed rule without taking
a position on any of the proposals.
---------------------------------------------------------------------------

One-hundred two of the comments came from originators/
servicers.11 Fourteen comments came from trade associations.
Four came from individual consumers, three from tax service providers,
two from members of Congress, four from financial software companies,
one from a state lending agency, one from a mortgage insurer, one from
a builder, and two from persons whose professional interest in the rule
could not be determined.
---------------------------------------------------------------------------

\11\ In some cases, the precise nature of the business was not
clear from the comment. Moreover, it did not appear that the
comments differed markedly depending on the precise nature of the
business. For example, it did not appear that the comments from
retail lenders differed markedly from those from mortgage brokers,
or that the comments from one type of retail lender differed from
those or other types of retail lenders. Thus, all businesses that
originate, service, and/or broker loans are designated as
``originators/servicers'' in this preamble.
---------------------------------------------------------------------------

B. What Commenters Commented On

The Annual vs. Installment Disbursements problem attracted the most
comments. One-hundred twenty-eight commenters, including all but one of
the trade associations and all but two of the originators/servicers,
commented on this issue. The Payment Shock Problem received the second
highest number of comments, with one-hundred

[[Page 3221]]

sixteen commenters, including ninety-six originators/servicers and all
but two of the trade associations. The Single-Item Analysis With
Aggregate Adjustment problem also attracted a significant number of
comments, seventy-eight in all, including sixty-five originators/
servicers and ten trade associations. Only seventeen commenters, twelve
originators/servicers and five trade associations, commented on the
additional proposed change concerning lead-based paint.

C. Overview of Positions

The overwhelming majority of originators, servicers and mortgage
brokers opposed those options for the first two issues that were
designed to provide borrowers more choices, citing the costs and
burdens of such an approach. Three commenters, including Norwest,
criticized those options as being inconsistent with the principles the
Department had articulated, asserting that the Consumer Choice options
would increase the cost of homeownership. In contrast, the few
consumers and members of Congress who commented on the first issue
supported Consumer Choice approaches; these commenters did not comment
on the Payment Shock problem.
On the Single-Item Analysis With Aggregate Adjustment problem, more
commenters supported the proposed change than opposed it. Opinion was
nearly evenly divided on the additional proposed change concerning
lead-based paint.
Nine commenters, including the American Bankers Association (ABA),
commented that no changes should be made at this time and instead, the
Department should wait several years before considering further changes
to Regulation X, at least until the changes made under the 1994-1995
escrow rules are fully implemented. (Those provisions took effect May
24, 1995 but provided for a three-year phase in for existing escrow
accounts which expires October 27, 1997.)
The reasons given by the ABA, which were echoed by the Oregon
Bankers Association, for not making any changes to the rule were that
the rule would alter the escrow accounting systems at the very time the
Department's new rules are bring fully implemented, causing major
problems and an excessive burden for banks and other mortgage
servicers. The New York Credit Union League agreed, emphasizing the
costly changes that are already being made as a result of that earlier
rule.
A bank holding company, in terms echoed by other originators and
servicers, commented that there was no need to change the rules now as
those borrowers with existing accounts have already benefited from or
suffered the consequences of the 1994-1995 escrow rules and have
subsequently adjusted to the changes and many of the problems created
by that rule are over. Thus, it would be premature to make further
changes, and doing so may only again create the same sort of initial
problems that were created by the 1994-1995 escrow rules. GE Capital
recommended waiting at least two years before revisiting the need for
any changes. Another servicer and originator recommended waiting 24 to
36 months before making further changes. A bank compliance officer and
a bank holding company also recommended against changes being made at
this time.
Several other commenters recommended that the Department hold off
action on specific portions of the rule. Those comments are analyzed
separately under the portion of the preamble discussing that aspect of
the rule.
In contrast, many commenters emphasized the importance of making
changes to address their particular issues of concern, particularly the
Payment Shock problem. These comments are summarized under the
particular issues discussed later in this summary.

V. Annual vs. Installment Disbursements Problem--Comments Received,
Approach Adopted in Today's Final Rule, Basis for Approach Adopted,
Basis for Rejecting Alternative Approaches, Clarifications

A. Comments Received

Through the comments received on the proposed rule, the Department
gained a better understanding of the Annual vs. Installment
Disbursements problem. The Department learned more about how servicers
have been addressing the problem of setting the appropriate
disbursement date when given a choice of annual or installment
disbursements. The comments received indicated that practices have not
been uniform and that in some cases, originators/servicers have been
using creative approaches to meeting consumer's needs. Five
originators/servicers and two tax services indicated that they were
disbursing in installments unless a discount was offered for annual
disbursements that the servicer thought was a large enough discount to
be in the borrower's interest, in which case the disbursements were
made annually; one trade association indicated this was the approach of
most of its members as well. One savings and loan indicated that its
practice was to accommodate individual borrowers by switching people
who complain to whichever method they prefer.
Other originators/servicers are using practices that do not provide
as much flexibility for the consumer. In many cases, the originators/
servicers indicated that they believed such practices were compelled by
the existing RESPA regulations. For example, thirteen originators/
servicers indicated that when such a choice is offered, they currently
disburse in installments unless a discount is offered for annual
disbursements, in which case they always disburse annually regardless
of how insignificant the discount may be. Two originators/servicers and
one tax service indicated that if no discount is offered for annual
disbursements but a service fee is charged for installment
disbursements, they disburse annually, no matter how insignificant the
service fee may be.
A few commenters noted that in many jurisdictions, the installment
option is only available for individuals, not servicers. Other
commenters noted special rules that apply in particular States, such as
Wisconsin, where the practice is to pay taxes in the year levied, even
though they do not have to be paid until the following year, and
Maryland, where a law provides that first time homebuyers may choose
between annual and installment disbursements with a consumer disclosure
highlighting differences between the two methods.
The Department also learned more about the discounts obtained by
servicers for borrowers, e.g., how large the discounts are and when
disbursements must be made in order to receive the discounts.
Commenters estimated the size of the discounts to range from around 1-5
percent of the property tax bill, with only two commenters indicating
that discounts ranged up to 10 percent, and only one commenter
indicating they tended to be less than one percent. Several
commenters--three consumers, two members of Congress, two originators/
servicers, one trade association--expressed the view that discounts are
small and not in the borrower's interest to disburse in order to
collect them. Two originators/servicers expressed the opposite view
that discounts tended to be large and in the borrower's interest to
obtain. The Department notes that, under reasonable
assumptions,12 a

[[Page 3222]]

discount of 1 percent of the annual tax bill converts to approximately
a 4 percent annualized return; a 5 percent discount converts to
approximately a 23 percent annualized return.
---------------------------------------------------------------------------

\12\ The assumptions are that if, for example, the entire tax
bill is paid on January 1, the discount applies to the entire bill.
Otherwise, half of the bill is due on January 1 and half is due on
July 1.
---------------------------------------------------------------------------

Several commenters commented on the extent of the problem. Two
consumers from New York asserted that borrowers whose servicers
switched from installments to annual disbursements were adversely
impacted. One, a senior citizen, explained that she and her husband
were required by their servicer either to make a lump sum payment of
almost $1,500 with a monthly increase of over $150 or no lump sum
payment but a monthly increase of over $200, to obtain a discount of
only 1 percent. Another reported that his mortgage payment was
increased over $100 for a mere $8 discount for annual tax payments.
Other commenters, however, challenged the Department's perspective
that the issue of Annual vs. Installment Disbursements was a problem in
need of fixing. Some questioned the Department's evidence that there
was a problem. One bank expressed doubt about how many borrowers were
actually affected, and to what extent, by the 1994-1995 escrow rules,
indicating that the impact of the rule change had already been
absorbed. Four originators/servicers, including Citicorp and First
American Real Estate Tax Service, Inc., a large tax service,
specifically asserted that there was no current problem. Citicorp
asserted that there were few problems with the existing rule for
borrowers or industry and that it was premature to change the 1994-1995
escrow rules until there was more experience operating under it.
Citicorp recommended waiting until 1998 to make further changes. Ten
commenters in the origination and servicing industry, including
NationsBank and GE Capital, as well as the Mortgage Bankers Association
(MBA), also asserted that the impact of the 1994-1995 escrow rules had
already been absorbed, and any impacts on consumers with existing loans
had already taken place.
Most of the commenters commented on one or more of the specific
alternative proposals for addressing the problem.13 The
overwhelming majority of originators, servicers, and mortgage brokers
opposed Consumer Choice; there was some division of opinion on what
alternative approach to take. A modified version of the ``Keep But
Clarify Current Requirements'' alternative garnered the most consistent
support; the modification was that the restriction on servicers
switching disbursement methods when servicing is transferred be
eliminated. Opinion was fairly evenly divided on the merits of the
``Servicer Flexibility'' alternative.
---------------------------------------------------------------------------

\13\ In contrast, one commenter, a Wisconsin bank holding
company, seemed to question the Department's legal authority to
propose any solution to the problem. The commenter asserted that the
Department can prohibit over-escrowing and pre-accrual or other
servicer practices ``that require borrowers to have more than the
amount of the projected property tax plus the permissible cushion in
the escrow account before the tax lien attaches, but it was not the
purpose of Congress that RESPA limit a lender's right to keep
mortgaged property free of liens, and the authority of the
Department to interpret RESPA so as to do so is questionable.'' The
commenter criticized any proposal that would establish detailed
rules regarding when servicer may disburse funds to pay property
taxes after the tax lien has attached to the property.
This objection seems to raise an issue that was settled in the
May 1995 rule, which elevated cash flow over lien priority. The
Department has clear legal authority to address the matter of
disbursements, as part of the Secretary's rulemaking authority
pursuant to section 19(a) of RESPA (12 U.S.C. 2617) to interpret
RESPA, including section 10 and section 6(g). Section 10(a) requires
that disbursements be made in accordance with prudent lending
practice. Section 10(a)(2) prohibits lenders from requiring
consumers to deposit in escrow accounts more than one-twelfth of the
total amount of the estimated taxes, insurance premiums and other
charges which are ``reasonably anticipated'' to be paid on dates
during the ensuing twelve months plus a cushion. Section 6(g)
requires that disbursements be made as payments become due. By
promulgating a rule to address the Annual vs. Installments
Disbursement problem, the Department would be acting appropriately
under one or more of these statutory provisions.
---------------------------------------------------------------------------

1. Comments on Consumer Choice Alternative
Only seven commenters supported Consumer Choice. The California
Association of Realtors (CAR) specifically supported applying the
Consumer Choice option to new loans as well as existing loans. CAR
commented that the benefits would outweigh the marginal costs and that
it favored approaches that provide consumers with as much information
as possible and the opportunity, when fully informed, to make choices
about the servicing of their loans and the related impound/escrow
accounting. The CAR added that if the consumer failed to make a choice,
disbursements should be made on an installment basis.
Two comments from elected officials, one from Representative Peter
King of New York and one joint letter from Senator Alphonse D'Amato,
Representative King, and Representative Dan Frisa also endorsed the
Consumer Choice approach, focusing on its application to existing
loans. Both letters expressed deep concern for homeowners who were
negatively impacted when servicers switched disbursement methods and
urged the Department to allow homeowners to have the choice to return
to their prior disbursement method. Representative King's letter stated
that consumers, not financial institutions, will be able to determine
which method of tax payment is best for them and that allowing such a
choice would further the goals of RESPA. Senator D'Amato's letter
stated that ideally homeowners should be given the option to return to
their previous disbursement methods with the excess of any escrow
accounts returned and, at a minimum, their servicers must inquire as to
the homeowners' preference.
Four homeowners in New York advocated allowing homeowners to have
the right to decide whether they wish to forego a discount for annual
disbursements and instead have their taxes disbursed in installments.
All focused on the benefits of applying Consumer Choice to existing
loans, complaining that they were left with a shortage in their account
and suffered severe financial hardship trying to make up the shortage
when their servicers switched disbursement methods.
In addition, one federal credit union's comments gave tepid support
to the Consumer Choice option if it were limited to new loans. The
credit union indicated that offering the choice to new loans would only
entail the burden of preparing and explaining the form. It indicated,
however, that for existing loans Consumer Choice would be costly in
terms of staff, time, and the mailing of the selection format, and
would be confusing to borrowers. The credit union also indicated that
since borrowers could refinance anyway, there was no apparent need to
offer existing borrowers a choice.
In contrast, 107 commenters opposed the adoption of Consumer Choice
(91 originators/servicers, 11 trade associations, 3 tax services, 2
financial software companies, and 1 person whose professional interest
was not known). Only one commenter, a credit union, appeared to limit
its opposition to the Consumer Choice alternative to its application to
existing loans. All of the other commenters appeared to oppose the
application of Consumer Choice regardless of whether it extended to
both new and existing loans, or only to new loans.
Most commenters did not separate out their objections to Consumer
Choice as it would apply to new loans as opposed to existing loans.
Whether the commenters separated out their objections or not did not
affect the objections raised. Accordingly, all objections are discussed
together below,

[[Page 3223]]

with an indication, as applicable, if an objection was raised
specifically in one context as opposed to another.
The most common objections made by commenters were:
1. It would cause miscellaneous or general increases in costs and/
or administrative burdens, such as costs and burdens relating to
originating or servicing (64 commenters--60 originators/servicers, 3
trade associations, 1 tax service).
2. They were concerned about the specific costs and burdens of
consumer disclosure, including producing and mailing disclosures,
soliciting preferences, processing disclosures, tracking selection, and
maintaining information on selection (50 commenters--45 originators/
servicers, 4 trade associations, 1 financial software company) or
opposed the addition of a new disclosure in general (8 commenters--6
originators/servicers, 1 financial software company, 1 person of
unknown professional interest).
3. It would require more customer service to explain choices and
answer questions for consumers, which would raise costs, workload, and
require more staff (46 commenters--41 originators/servicers, 4 trade
associations, 1 financial software company).
4. The cost would be passed on to consumers (44 commenters--35
originators/servicers, 6 trade associations, 2 tax services, 1
financial software company).
5. They did not want to make the system and programming changes,
acquire the new software, or incur the expense of additional
programming that would be needed (38 commenters--32 originators/
servicers, 3 trade associations, 2 financial software companies, 1 tax
service).
6. It would cause consumer confusion and consumers would not be
able to make an educated choice (30 commenters--25 originators/
servicers, 3 trade associations, 1 financial software company, 1 person
of unknown professional interest).
7. They did not want to have to maintain two, or possibly many
more, different disbursement systems for every taxing jurisdiction
where they service loans (24 commenters--18 originators/servicers, 5
trade associations, 1 tax service).
8. It would lead to more errors and could result in missed payments
and interest and penalties (24 commenters--21 originators/servicers, 1
trade association, 1 tax service, 1 financial software company).
9. It would create hardship for taxing authorities (18 commenters),
such as increased administrative costs/burden and workload due to lack
of uniformity and similar factors (12 originators/servicers),
unexpected shortfalls in tax receipts (8 commenters--7 originators/
servicers, 1 trade association), and unspecified or miscellaneous
difficulties (2 originators/servicers).
10. It would require additional training of staff (8 commenters--7
originators/servicers, 1 trade association) or require additional staff
and/or staff time for processing (13 commenters--12 originators/
servicers, 1 trade association).
11. It would result in impossibilities and impracticalities (15
commenters) including that computer and other systems could not handle
Consumer Choice (6 commenters--5 originators/servicers, 1 trade
association).
12. It would increase the need for manual processing or interfere
with technological advances (12 commenters--10 originators/servicers, 1
tax service, 1 financial software company).
13. It would be less efficient (11 commenters--10 originators/
servicers, 1 trade association).
14. It would result in a loss of uniformity (10 commenters--9
originators/servicers, 1 trade association).
In addition, several commenters indicated that several aspects of
the Consumer Choice alternative in the proposed rule were unclear and
required further clarification. For example, eight originators/
servicers and a trade association indicated that the proposed rule was
not sufficiently clear about what would happen if the customer did not
return the format or how a servicer should document that a borrower
made no selection. Several commenters recommended that if the
Department were to proceed with Consumer Choice, it should make
variations of one type or another from the way in which it was
proposed.
In its proposed rule, the Department asked Question 4, which was
designed to learn more about the potential impact on servicers of
requiring them to provide borrowers with a one-time choice at closing
as opposed to allowing borrowers to switch disbursement methods during
the life of the loan. The answers received to this question
substantially overlapped with the comments discussed above regarding
the benefits and disadvantages of Consumer Choice.
Twenty-eight commenters (24 originators/servicers, 3 trade
associations, 1 tax service) explicitly indicated in their responses to
this question that not even a one-time choice should be provided to
consumers, but that if the Department chose the Consumer Choice
alternative anyway, it should be limited to a one-time choice. This
view was implicit in the comments of several others. Among the
drawbacks cited for providing more than a one-time choice were the
following:
1. It would increase the burden if servicers needed to make
constant changes (nine commenters--eight originators/servicers, one
trade association).
2. It would result in higher costs (eight commenters--seven
originators/servicers, one tax service).
3. It would lead to more errors, confusion, uncertainty and/or
noncompliance (seven commenters--five originators/servicers, one trade
association).
4. It would be impossible, impractical, or unfair (five
originators/servicers).
In its proposed rule, the Department also asked three related
questions (Questions 2, 5, and 11) that were designed to elicit
responses as to whether, in general, the approach in the final rule
should make a distinction between loans that settle before the
effective date of a final rule and loans that settle on or after the
effective date. While the Department posed the questions so as to be
applicable regardless of which alternative was selected, virtually all
who answered the questions did so in the context of applying Consumer
Choice. The answers received to these questions substantially
overlapped each other, as well as overlapping with the comments
received on Consumer Choice, and thus are discussed together here.
Fourteen commenters--twelve originators/servicers and two trade
associations--emphasized the drawbacks to applying new rules to
existing loans, as opposed to only applying it to new loans. The
drawbacks to applying consumer choice to all loans included: (1) it
would be more costly/burdensome to apply to all (eight commenters); (2)
it may result in shortages (two commenters); and (3) it would cause
more confusion, disruption, and/or chance for error (two commenters).
In contrast, 13 commenters--11 originators/servicers, 1 trade
association, and 1 financial software company--emphasized the drawbacks
to trying to apply new rules only to new loans, thereby requiring
maintaining separate rules for a portion of their portfolio. These
commenters either supported or leaned toward uniform treatment of all
loans, some with mixed feelings about the significant burdens it would
impose to apply a change to existing loans. The drawbacks cited

[[Page 3224]]

included: (1) the need for uniformity and consistency (five
commenters); (2) it would be costly and burdensome to distinguish (four
commenters); (3) it would result in more borrower confusion or
dissatisfaction (three commenters); (4) taxing authorities could not
gauge the number and amount of tax payments (two commenters); and (5)
more errors would result.
Finally, in the proposed rule the Department asked Question 10,
which was designed to elicit comments on whether the Department should
apply a Consumer Choice approach to other escrow items for which a
choice between installments and annual disbursements may be offered. No
commenter gave a clear answer that supported applying a consumer's
choice to other escrow items. In contrast, 27 commenters (23
originators/servicers and 3 trade associations) opposed extending a
consumer's choice to other escrow items. The reasons given for opposing
such an approach included the following:
1. Additional costs and burdens would result (e.g., insurance
companies impose a service charge for installment payments and this
would be passed on to consumer) (19 commenters--17 originators/
servicers, 2 trade associations).
2. There would be no benefit to consumers (e.g., taxes are the
largest item so the savings from installments will be negligible) (10
commenters--9 originators/servicers and 1 trade association).
3. More errors, customer dissatisfaction, and customer confusion
would result (six commenters--five originators/servicers and one trade
association).
2. Comments on Servicer Flexibility Alternative
Twenty-five commenters--18 originators/servicers, 5 trade
associations, 1 tax service, and 1 financial software company--
supported Servicer Flexibility. Eight of these commenters (seven
originators/servicers and one financial software company) who otherwise
supported Servicer Flexibility, however, did not support the aspect of
Servicer Flexibility that would have included restrictions on changing
disbursement methods when servicing rights were transferred. Indeed,
two of these originators/servicers made a special point of indicating
that they would not support Servicer Flexibility if it included that
element.
The most common reasons for supporting Servicer Flexibility
included:
1. It would be flexible (six commenters--three originators/
servicers, three trade associations).
2. It would be easy to administer and cause little disruption (five
commenters--two originators/servicers, two trade associations, one
financial software company).
3. It would not be costly (four originators/servicers).
4. The lender/servicer is likely to do what is in the consumer's
interest anyway; Servicer Flexibility would allow servicers to
accommodate borrowers (four commenters--two originators/servicers, two
trade associations).
In contrast, 19 commenters--14 originators/servicers, 4 trade
associations, and 1 tax service--opposed Servicer Flexibility. The
reasons for opposing Servicer Flexibility included:
1. It would not create a system that is uniform, standardized,
consistent, or certain; there would still be no clarity (12
commenters--9 originators/servicers, 2 trade associations, 1 tax
service).
2. The restriction on changing disbursement methods when there is a
transfer of servicing or reasons related thereto was objectionable
(five commenters--three originators/servicers, one trade association,
one tax service).
3. Increased costs would result (five commenters--four originators/
servicers, one trade association).
4. It might not result in the best method for consumers (two
originators/servicers, one trade association) and litigation would
result (two originators/servicers).
In addition, one federal credit union suggested that the Department
adopt a variation on Servicer Flexibility under which the servicer
should notify the borrower when the disbursement method is being
changed, changing should be limited to when it benefits the borrower
(such as taking advantage of a sufficient discount), and the annual
statement could be used to inform the borrower of the method used.
3. Comments on Keep, But Clarify, Current Requirements Alternative
Sixty-five commenters--58 originators/servicers, 4 trade
associations, 1 tax service, 1 financial software company, and 1 State
lending agency--supported the Keep, But Clarify, Current Requirements
alternative. Six other commenters (two originators/servicers, three
trade associations, and one tax service) indicated it was their second
choice. Forty-eight of the commenters who otherwise supported Keep, But
Clarify, Current Requirements as either their first or second choice
(46 originators/servicers, 1 trade association, and 1 State lending
agency), did not support the aspect of this alternative that would
include restrictions on changing disbursement methods when servicing
rights were transferred. Indeed, 30 of these commenters specifically
emphasized their objection to this aspect of this alternative in
discussing the support they otherwise would give to it.
The reasons given by those who supported Keep, But Clarify, Current
Requirements as their first choice were substantially the same as the
reasons given by the three originators/servicers who indicated it was
their second choice. The most common reasons of both groups of
commenters included:
1. It would be good for consumers for miscellaneous or unspecified
reasons (26 commenters--24 originators/servicers, 1 State lending
agency, 1 financial software company) or because it would be flexible
and allow accommodating customers (8 commenters--5 originators/
servicers, 3 trade associations).
2. It would cause little disruption, would not be burdensome, would
not require much change, and would be efficient (11 commenters--8
originators/servicers, 2 trade associations, 1 State lending agency).
3. It would not be costly and any costs associated with it would be
within an acceptable range (eight commenters--six originators/
servicers, two trade associations).
4. It would be a balanced, sensible, practical compromise (six
commenters--five originators/servicers, one trade association)
5. It was favored but no specific reason was given (20 commenters--
17 originators/servicers, 2 trade associations, 1 tax service).
In contrast, eight originators/servicers and two trade associations
opposed Keep, But Clarify, Current Requirements. The most common
reasons given for opposing it included the following:
1. It would not standardize the industry (two originators/
servicers).
2. It would be unclear, vague, and not specific (two originators/
servicers).
3. It would be bad for consumers (e.g., consumer dissatisfaction,
confusion, disruption, loss of tax deduction) (two originators/
servicers, one trade association).
4. It would be objectionable because of the restriction on
switching disbursement methods when there is a transfer of servicing
(two commenters--

[[Page 3225]]

one originator/servicer, one trade association).
Several commenters recommended variations on Keep, But Clarify,
Current Requirements such as requiring installments unless there is a
discount for annual disbursements, in which case making annual
disbursements mandatory to get the discount instead of optional for
servicer. Other commenters encouraged the Department to consider other
approaches, such as making no changes at all to address this problem.
4. Comments on Proposed Rule Provision Prohibiting Switching
Disbursement Methods Without Borrower's Consent
Only seven commenters supported, in any context, prohibiting a
servicer or transferor servicer from changing the disbursement method,
as long as a choice exists, without the borrower's prior written
consent. Two appeared to support it as a general proposition regardless
of the alternative selected. One was Senator D'Amato, who asserted that
changes without the borrower's approval ``have been the primary culprit
in the unfair treatment which mortgage lenders have imposed on the
homeowners of Long Island, chiefly by requiring hundreds of dollars per
month from homeowners in escrow payments in order to take advantage of
minuscule discounts through the payment of local taxes on an annual
basis.'' The other was a federal savings bank, which gave no specific
reasons other than suggesting it would be less complicated to do so.
One servicer indicated that if Servicer Flexibility were adopted,
it would be logical to prohibit subsequent servicers from changing the
disbursement method without the borrower's written consent. This
commenter stated that it understands the need to get the borrower's
consent before changing the method of tax disbursements when servicing
is transferred.
Were the Department to adopt the alternative of Keep, But Clarify,
Current Requirements, three commenters supported the restriction.
America's Community Bankers (ACB) supported the restriction, so long as
the disbursement method continues to be offered by the taxing
authority. A large bank with a mortgage lending subsidiary endorsed
allowing servicers and subsequent servicers to change the disbursement
method only to bring the escrow account into compliance with RESPA
under a revised interpretation by the Department. One other servicer
commented that requiring the same disbursement date when servicing is
transferred is beneficial in that it protects against payment shock for
borrowers.
In contrast, 71 commenters opposed the restriction. Fifty-seven of
those who opposed it (including 21 originators/servicers submitting the
same form letter) discussed their opposition as a general objection
applicable to whichever of the three alternatives for addressing the
Annual vs. Installment Disbursements problem might be adopted. These 57
included 51 originators/servicers, 4 trade associations, a State
lending agency, and a financial software company. Fourteen expressed
their opposition in connection with one or more of the specific
alternative solutions proposed, but none of these commenters either
stated or suggested that the proposal would be acceptable in the
context of a different alternative being adopted. Since the objections
were consistent regardless of whether expressed in connection with one
or all alternatives, all the comments on this issue are discussed in
this section. One servicer specifically said that it opposed all the
alternatives presented in the proposed rule because of this common
feature.
The arguments against including the restriction in the final rule
primarily focused on the way in which such a restriction would impair
the value of servicing rights and the costs and administrative burdens
associated with the restriction. Many of the arguments against the
restriction overlapped each other. The most common reasons given
included that:
1. It would result in a variety of miscellaneous administrative
burdens (35 commenters--34 originators/servicers and 1 trade
association).
2. It would increase costs for servicers, such as system and
processing changes including computer system changes and the burden on
the due diligence process (14 commenters--12 originators/servicers and
2 trade associations) and would increase costs to consumers (6
commenters--4 originators/servicers and 2 trade associations).
3. The restriction would impair the value of servicing rights (13
commenters--10 originators/servicers, 2 trade associations, 1 State
lending agency), such as by creating inefficiency and increased cost (3
originators/servicers, 1 trade association).
4. As the restriction applies to the Keep, But Clarify, Current
Requirements alternative, it would be a new requirement, rather than a
clarification of an existing requirement (seven commenters--six
originators/servicers and one trade association).
5. It would result in a variety of practical difficulties or
impossibilities (six commenters--five originators/servicers and one
trade association).
6. It would reduce the number of sales and transfers of servicing
rights (five commenters--four originators/servicers and one trade
association).
7. No problem exists that needs to be fixed by such a restriction
(five originators/servicers).
In addition, three commenters (two originators/servicers, one trade
association) indicated their belief that the Department would lack
legal authority to mandate such a restriction. Three originators/
servicers requested that the Department clarify certain points
pertaining to this restriction.
Six commenters proposed variations on the restriction. Three
commenters supported limiting the ability of the acquiring servicer to
change the disbursement method to particular types of situations. One
federal credit union indicated that it supported restricting a servicer
acquiring servicing rights from changing disbursement methods unless
the change would benefit the borrower, but gave no details on how to
apply such a standard. The Georgia Housing and Finance Administration
favored limiting servicers from making changes to the disbursements
method to situations involving transfers of servicing, borrower
hardships, taxing authority changes, system conversion, and other major
organizational changes. GE Capital asked the Department to allow a
change in disbursement dates or methods after a transfer of servicing
if the dates are incorrect or the methodology is not available to the
new servicer. Three mortgage companies suggested that servicers should
simply include in the letter notifying the consumer of a transfer of
servicing what disbursement method will be used, prior to making the
change.

B. Approach Adopted in Today's Final Rule

Having carefully analyzed the comments received, the Department has
decided to adopt, with modifications, the Keep, But Clarify, Current
Requirements alternative. The Department is revising the rule to
provide that servicers must make timely payments, that is, on or before
the deadline to avoid a penalty, and advance funds as necessary, so
long as the borrower's payment is not more than 30 days overdue. The
rule also provides special requirements for property taxes when the
taxing jurisdiction offers the servicer a choice between annual
disbursements with a discount and installment disbursements. In such

[[Page 3226]]

cases, if the taxing jurisdiction neither offers a discount for
disbursements on a lump sum annual basis nor imposes any additional
charge or fee for installment disbursements, the servicer must make
disbursements on an installment basis, unless the servicer and borrower
agree otherwise. If, however, the taxing jurisdiction offers a discount
for disbursements on a lump sum annual basis or imposes any additional
charge or fee for installment disbursements, the servicer may, at the
servicer's discretion (but is not required by RESPA to), make lump sum
annual disbursements, as long as such method of disbursement complies
with the requirements of Sec. 3500.17 (k)(1) and (k)(2) of this rule.
HUD encourages, but does not require, the servicer to follow the
preference of the borrower, if such preference is known to the
servicer.
This final rule also incorporates into the regulations a provision
that the servicer and borrower may mutually agree, on an individual
case basis, to a different disbursement basis (installment or annual)
or disbursement dates, than the rule would otherwise require. This
provision is consistent with, but more expansive than, the statement
contained in the discussion in the preamble to the Department's May 9,
1995 rule (60 FR 24734), which indicated that such agreements were
allowed after settlement only. At the time the preamble to the May 1995
rule was written, the Department felt that the concern for borrower
coercion was so great as to make it necessary to limit agreements
concerning disbursement dates to the period after settlement, when the
likelihood of coercion was reduced. The Department understands,
however, that allowing such agreements only after settlement
discourages them, since it is more burdensome to change the
disbursement basis or date after settlement than to set up the account
from the start in a way that is mutually agreeable to the borrower and
servicer.
This final rule emphasizes that these agreements must be completely
voluntary and that neither loan approval nor any term of the loan may
be conditioned on the borrower's agreeing to a different disbursement
basis or disbursement date for property taxes. The rule does, however,
allow such agreements to be made prior to settlement, thereby avoiding
the need to make postsettlement changes in the disbursement basis or
dates when such an agreement is reached before settlement. This rule
also clarifies that whatever the borrower and servicer agree to must
avoid a penalty, comply with normal lending practice of the lender and
local custom, and constitute prudent lending practice. This new
provision provides flexibility. It allows the parties to agree, for
example, to annual disbursements of property taxes even if there is no
discount where an installment option is offered.
This final rule departs from Keep, But Clarify, Current
Requirements as articulated in the proposed rule in that, under this
final rule, the only specific requirements for choosing between annual
and installment disbursements pertain to property taxes, not other
escrow items. The reason the Department distinguishes property taxes
from other escrow items is that the concerns that have been raised to
the Department on the Annual vs. Installment Disbursement issue have
been limited to property taxes. For most consumers, property taxes are
much larger than hazard insurance and other escrow items.
This final rule also departs from Keep, But Clarify, Current
Requirements as articulated in the proposed rule in that, for the
reasons discussed in Part V(D)(3) of this preamble below, it does not
adopt the restriction in the proposed rule that a servicer and
subsequent servicers would be prohibited from changing the method of
disbursement without the borrower's prior written consent, as long as a
choice continues to exist in the taxing jurisdiction.
Finally, the final rule adds a definition of ``penalty'' to the
definitions in Sec. 3500.17. This definition clarifies that a penalty
means a late charge imposed for paying after the disbursement is due.
It does not include any additional charge or fee associated with
choosing installment disbursements as opposed to annual disbursements
or for choosing one installment plan over another. In comments on the
proposed rule, four originators/servicers and one tax service commented
that the proposed rule had been unclear whether a service fee levied on
installment disbursements is regarded as a penalty. These commenters
took the position that the servicers may or must use annual
disbursements to avoid a penalty (service charge, interest payment, or
other fee) for paying in installments, not just to take advantage of a
discount available for annual disbursements. One of these commenters
questioned whether the existence of a service charge for installment
disbursements makes an annual disbursement plan without such a service
charge the equivalent of a discount.
Notwithstanding these comments, the Department believes the better
approach is not to regard a service charge, interest payment, or other
fee associated with choosing installment disbursements as opposed to
annual disbursements as a penalty to be avoided. Rather, if a service
charge, interest payment, or other fee is imposed for choosing
installment disbursements as opposed to annual disbursements, the
ability to avoid them by paying annually creates, in essence, a
discount for annual disbursements. With respect to disbursements for
property taxes, once the choice is viewed as between annual
disbursements at a discount and installment disbursements, in
accordance with this rule, the servicer may, but is not required by
RESPA to,14 pay annually. Thus, for property taxes, the
servicer may choose to disburse the property taxes in installments and
incur the service charge, interest payment, or other fee associated
with choosing installment disbursements, or may avoid them by
disbursing annually. The servicer is encouraged, but not required, to
follow the preference of the borrower.15
---------------------------------------------------------------------------

\14\ The caveat, ``by RESPA,'' is designed to allow for the
possibility that State law could require annual disbursements.
\15\ For other escrow items, the servicer may disburse annually
or in installments, so long as the method avoids a penalty and the
disbursement basis and disbursement date complies with the normal
lending practice of the lender and local custom, and constitutes
prudent lending practice.
---------------------------------------------------------------------------

Stated in other terms, for property taxes, the servicer should add
up the total payments associated with disbursing annually and compare
that amount to the total payments associated with disbursing in
installments. In making those calculations, the servicer should take
into account any applicable discounts or service charges. If the total
amount associated with disbursing property taxes annually is greater
than or equal to the total amount associated with disbursing in
installments, the servicer must disburse the property taxes in
installments, except when the servicer and borrower mutually agree
otherwise. If, however, the total amount for disbursing the property
taxes in installments is greater than the total amount for disbursing
them annually, the servicer may, but is not required by RESPA to,
disburse them annually. The servicer is encouraged, but not required,
to follow the preference of the borrower.

C. Basis for Approach Adopted

The preamble to the proposed rule indicated that the Department
believed the advantage of Keep, But Clarify, Current Requirements would
be that, like Servicer Flexibility, it would provide flexibility to
servicers. It would also allow servicers to accommodate borrowers with
a particular preference.

[[Page 3227]]

To the extent that the Department thought Keep, But Clarify, Current
Requirements had a potential drawback, it was that it would not
guarantee that servicers would accommodate the preferences of
individual borrowers, providing less choice for borrowers.
The comments received served to confirm the Department's belief
that Keep, But Clarify, Current Requirements, with some modifications,
is a workable solution to this problem. Commenters noted many positive
reasons for choosing this alternative. The Department is persuaded
that, on balance, it is the best approach for meeting consumers' needs
and balancing those against the valid concerns of the industry. Such an
approach will cause the least disruption and burden and will be the
least costly approach, yet it is sufficiently flexible to accommodate
the preferences of individual consumers.
By clarifying the regulations in a way that allows more flexibility
for servicers and consumers, the Department intends to encourage more
servicers to adopt the types of best practices that some servicers are
already using that ensure flexibility for consumers. These best
practices to address the Annual vs. Installment Disbursements problem
include:
Disbursing property taxes in installments unless a
discount is offered for annual disbursements that the servicer, based
on its best business judgment, believes is a large enough discount to
be in the borrower's interest, in which case the servicer makes
disbursements annually.
Accommodating individual borrowers by switching borrowers
who complain to whichever method they prefer for the disbursement of
property taxes.
These two practices are examples of the types of best practices
that some originators/servicers in the industry are using today, even
without a Government requirement. The Department would encourage
servicers to adopt these practices so that they will become more
widespread.
In contrast, the Department intends to discourage practices that do
not provide as much flexibility for the consumer. These include:
If a choice between annual disbursements with a discount
or installment disbursements is offered, always disbursing annually
regardless of how insignificant the discount may be and despite the
consumer's stated preference for installment disbursements.
If a choice between annual disbursements or installment
disbursements with an additional charge or fee for installment
disbursements is offered, always disbursing annually regardless of how
insignificant the charge or fee for installment disbursements may be
and despite the consumer's stated preference for installment
disbursements.
The Department intends that the revisions made in this final rule
clarify that these two inflexible practices were not, and are not,
compelled by the Department; the Department does not in any way mandate
such practices. The Department encourages servicers to use practices
that are more consumer friendly.

D. Basis for Rejecting Alternative Approaches

1. Rejection of Consumer Choice Alternative
The preamble to the proposed rule indicated that this approach
would provide the greatest flexibility to the borrower. However, the
Department also noted that it could impose higher costs on servicers.
The Department observed that servicers would likely need two different
disbursement systems to reflect the disbursement preferences of
borrowers.
While the Department believes that it would have legal authority to
impose Consumer Choice as part of the Secretary's rulemaking authority,
it has decided not to do so. The Department is persuaded that the types
of costs and burdens associated with such an approach are unwarranted
at this time. The cost of implementing Consumer Choice with respect to
disbursing property taxes on an installment or annual basis would be
substantial according to most of the comments received on this issue.
New software and operating procedures would have to be developed for
originators and all those involved in servicing. Some efficiencies
would be lost as multiple processes were employed for making
disbursements to taxing authorities, when only one process had been
followed before.
Additionally, the Department gathered information from members of
the servicing industry on the cost of the Consumer Choice alternative.
The Department believes that the cost per account subject to Consumer
Choice would be significant, even under a very simple system subject to
the following assumptions: (1) a choice would only be permitted at
origination with no provisions for the consumer to opt to change the
disbursement method later and (2) little in terms of disclosure to the
consumer would be provided other than notifying the consumer that a
one-time choice at origination was permitted. To the extent that the
disclosure required more information or the consumer could opt to
change the disbursement method during the life of the loan, the costs
would be greater.
The additional costs of consumer choice could be justified if there
were commensurate benefits to consumers. But the vast majority of
consumer complaints concerning the disbursement method arose out of the
transition associated with the 1994-1995 escrow rules. These were one-
time, as opposed to ongoing, problems. Complaints about this problem
have recently become rare.
Given that the transition associated with the 1994-1995 escrow
rules is almost complete and that this transition has been the source
of essentially all the complaints concerning the Annual vs. Installment
Disbursements problem, the Department believes that only a small
percentage of consumers would benefit from the Consumer Choice
alternative. It is not anticipated that the benefits to the few who
would choose a basis other than what the servicer would choose under
the rule would exceed the costs associated with that option. Since it
is consumers who would probably bear the additional costs of providing
choice, the Department does not believe it is in the consumers' overall
best interest to require consumer choice.
The Department was also influenced by the lack of consensus among
the commenters on the technical details of the Consumer Choice
alternative. The Department asked several specific questions about how
to implement such an option in the way least disruptive to the
industry. The answers received further reflected the uncertainties and
disruptions that would be created by imposing the Consumer Choice
alternative and helped convince the Department that such an approach is
not feasible. Since the Department is not adopting the Consumer Choice
alternative in this final rule, the responses received to a number of
the questions raised in the proposed rule do not merit detailed
discussion, but a brief summary of the comments in response to these
questions is provided below to convey the divergent opinions on this
subject.
1. The Department asked Question 7, which was designed to elicit
comments on when the appropriate time would be for the originator or
servicer to provide the borrower the disclosure, if the Consumer Choice
alternative were to be adopted. The commenters were fairly evenly
divided on whether the disclosure should be provided and the

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selection made before closing but after underwriting or before
underwriting. Thirteen commenters simply indicated sometime before
closing, whereas 12 commenters indicated it would have to be before
underwriting. Seven commenters specifically indicated that the
selection would affect underwriting, whereas three commenters
specifically indicated that the selection should not affect
underwriting.
2. The Department asked Question 8, which was designed to elicit
comments about whether the Department should prescribe a disclosure
format if an approach were adopted in which the borrower's preference
for installments or annual disbursements were controlling. There was
general agreement that the Department should prescribe the format (20
commenters supporting prescribing it, with only 4 opposed). However,
there was disagreement over what the disclosure should say. Six
commenters supported the disclosure the Department had proposed, if one
was to be mandated. Seven commenters, however, said it was too
confusing and/or unclear. Four criticized it for containing too much
information or being overwhelming whereas, two criticized it for not
including enough information.
3. The Department asked Question 9, which inquired what period of
time would be needed for servicers to be able to implement the Consumer
Choice alternative. Four commenters said it could be implemented in
less than 12 months, 9 commenters indicated 12 months or more, 2
commenters said 18 to 24 months, and 4 commenters estimated it would
take 24 months.
2. Rejection of Servicer Flexibility Alternative
The preamble to the proposed rule explained that the Department
perceived this alternative as being the least intrusive regulatory
approach for the Department to take and providing the greatest
flexibility to servicers, while leaving servicers free to accommodate
borrowers with a particular preference, as long as the borrowers'
preferences were in accordance with the normal lending practice of the
lender and local custom and constituted prudent lending practice. The
Department noted that the disadvantage of this alternative is that it
would not guarantee that servicers would accommodate the preferences of
individual borrowers and, therefore, it provided less choice for
borrowers.
The Department has decided not to adopt the Servicer Flexibility
alternative. Most commenters did not favor such an approach. The
Department decided that there is no reason to adopt this approach and
that it would not necessarily be best for the consumer.
3. Rejection of Prohibiting Switching Disbursement Methods Without
Borrower's Consent
While the Department would have legal authority to impose a
restriction against switching disbursement methods without the
borrower's consent as part of the Secretary's rulemaking authority, it
has decided not to do so. The types of costs and burdens associated
with such a restriction are unwarranted. Therefore, this final rule
does not contain this restriction as part of the approach adopted.

E. Clarifications

In issuing this final rule, the Department wishes to address
several questions from commenters that will clarify the rule.
1. Selecting From Among Various Installment Plans Offered
Several commenters requested clarification of the servicer's
obligations when a taxing authority offers several different
installment plans. In such circumstances, the Department encourages the
servicer to use the installment plan that results in the lowest closing
costs for the consumer. However, the servicer is free to make
disbursements according to any installment plan offered by the taxing
jurisdiction so long as the selection complies with the normal lending
practice of the lender and local custom, and the installment plan
selected constitutes prudent lending practice. The servicer may also
make disbursements according to any installment plan offered by the
taxing jurisdiction to which the servicer and borrower may mutually
agree, on an individual case basis.
2. The Size of the Discount Does Not Matter
One mortgage company commented that the Department should make the
application of the Keep, But Clarify, Current Requirements approach
more consistent by establishing a guideline on when to switch to annual
disbursements to take advantage of a discount. One tax service
indicated that when the payee offers a choice between installments and
annual disbursements at a discount, the Department should either
require maximum discounts be taken or set a threshold and require the
servicer to disburse to obtain any maximum discount meeting or
exceeding that minimum.
In its proposed rule, the Department asked Question 6, which
specifically solicited comments on whether the size of an available
discount should matter and, if so, how. Fifteen commenters--11
originators/servicers, 1 trade association, 2 tax services, and 1
financial software company--indicated that the size of the discount
should make a difference under the rule in some fashion. Eight
commenters indicated that the rule should provide that if the discount
offered meets a Department-determined threshold, the servicer must
disburse annually to obtain the discount. Three commenters indicated
that the rule should provide that the servicer is free to decide if the
discount is large enough to make it worthwhile to make disbursements in
such a way as to collect the discount.
Among those who favored making the size of the discount matter
under the rule, there was no agreement on the best approach to setting
the discount threshold that would trigger application of one rule or
another. Five commenters opposed tying the discount threshold to a
market rate, while only one supported this approach. Five commenters
favored, but two commenters opposed, a ``reasonable servicer''
standard. One large tax service commented that not just the size of the
discount, but several other factors, affect the value of the discount
to the consumer, such as the rate of interest (if any) paid on escrow
accounts, market interest rates, and the borrower's income tax rate.
In contrast, 16 commenters--15 originators/servicers and 1 trade
association--indicated that the size of the discount should not make a
difference under the rule. These commenters indicated that such
consideration would present an additional burden and cost to calculate
the size of the discount and that discounts are beneficial to the
consumer regardless of the size.
The Department has not adopted the approach of making the size of
the discount a determinative factor in which disbursement method the
servicer should use. There is no apparent way to arrive at a reasonable
and acceptable guideline. Rather, the Department's approach in this
rule allows latitude to the servicer, while encouraging the servicer to
follow the preference of the borrower.
3. Application of Rule to Other Escrow Items
Two originators/servicers commented that this rule should clarify
that the Department's policy of favoring installments only applies to
taxes, not other escrow items such as hazard

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insurance. One of these commenters added that this rule should clarify:
(1) that servicers should disburse mortgage insurance payments monthly
or annually; and (2) that hazard insurance payments should be disbursed
annually or as billed by the insurer, and if discounts are available
for annual disbursements it should be disbursed annually.
Under this final rule, the only specific requirements for choosing
between annual and installment disbursements pertain to property taxes,
not other escrow items such as hazard insurance. For escrow items other
than property taxes, if a payee offers a servicer a choice between
installment or annual disbursements, the servicer is required to make
disbursements by a date that avoids a penalty. The servicer, however,
is otherwise free to make disbursements on such disbursement basis
(annual or installments) and disbursement date as complies with the
normal lending practice of the lender and local custom, provided that
the selection of each such basis and date constitutes prudent lending
practice. The reason for distinguishing property taxes from other
escrow items is explained in Part V(B) of this preamble, above.
4. No Preemption of State Law on Installment Option
Two commenters requested clarification of whether RESPA preempts
State law in such a way as to require that States offer an installment
payments option to servicers, or if they currently only offer that
option to individual borrowers. The answer to that question is that
RESPA does not so preempt State law. Whether taxing jurisdictions
should make an installment option available to servicers is a matter of
State law, not RESPA.
5. Disbursing Annually Instead of in Installments When There is no
Discount if a Choice is Offered
One commenter, a Wisconsin bank holding company, raised a concern
regarding escrow accounts in Wisconsin, stating that servicers should
be able to make tax disbursements in an annual disbursement rather than
installments, if a choice is offered, even if there is no discount for
annual disbursements. The commenter represented that this was partly to
protect the servicer's lien, which becomes effective on the first of
the year in which the taxes are billed, and partly to give the borrower
the benefit of tax deductions for the current year. The commenter
explained that in Wisconsin, taxes are billed in November and can be
paid in two installments in the following January and July. In
addition, State law requires the servicer to issue a joint check to the
borrower and the taxing authority by December 20, or give the borrower
three options: (1) Pay in full by December 31 if the tax bill is
received by December 20, (2) pay the full tax when due (January and
July installments), or (3) issue a joint check to the borrower and
taxing authority by December 20. If the servicer offers the three
options, the servicer is required to follow the borrower's preference.
The commenter asserted that for the Department effectively to
prohibit the December payment would conflict with the Department's
prior guidance set forth in the preamble to the February 15, 1995 rule
(60 FR 8813, second column), which specifically allowed the practice.
The commenter further argued that a substantial change in
interpretation would undercut servicers who relied on the Department's
prior advice, would force servicers to disregard State law, and would
negatively impact on borrowers' tax deductions.
In response to this and other comments, this final rule adds a
provision to the regulations (Sec. 3500.17(k)(4)) specifying that a
servicer and borrower may mutually agree, on an individual case basis,
to a different disbursement basis (installment or annual) or
disbursement date than that which would otherwise be prescribed under
the regulations. This addition should address the commenter's concern
and allow the servicer to comply with Wisconsin law.

VI. Payment Shock--Comments Received, Approach Adopted in This
Final Rule, Basis for Approach Adopted, Basis for Rejecting
Alternatives

A. Comments Received

Through the comments received on the proposed rule, the Department
gained a better understanding of the payment shock problem. A few
commenters pointed out that there could be other causes of payment
shock aside from those that the Department had described in the
preamble to the proposed rule. Citicorp pointed out that payment shock
can also be caused by rate adjustments to Adjustable Rate Mortgages
(ARMs), special tax assessments, and additional insurance coverage
selected by borrowers after closing.
The Department also learned more about how servicers have been
addressing the problem of payment shock. Eight originators/servicers
indicated that their practice is to notify borrowers ahead of time and
provide an opportunity to make voluntary payments ahead of schedule to
avoid payment shock. Seven originators/servicers indicated that they
offer consumers extended repayment plans, even beyond those required
under RESPA, to make up shortages that result from payment shock. Nine
originators/servicers indicated that they use short-year statements to
minimize payment shock, a practice that also is useful. Two
originators/servicers indicated that they simply notify borrowers ahead
of time that payment shock may occur but do not explain how to avoid
it.
The Department solicited comments to gauge the extent of the
payment shock problem. Four originators/servicers and one home builder
specifically commented that they agreed with the Department's
assessment that payment shock is a very significant problem that needs
to be addressed. One commenter estimated that roughly 50 percent of its
customers experience payment shock because 30 percent of its loans are
for new construction on which taxes are initially assessed on
unimproved property and then reassessed for the improvements; an
additional 20 percent of its loans have prepaid taxes.
The view that payment shock was a problem was implicit in the
comments of several others, such as a servicer who indicated that the
current regulations do not work because of difficult situations with
borrowers that arise when payment shock occurs. Every commenter who
stated a reason for opposing the Make No Change alternative indicated
that they oppo

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A98-1395. Public record. Not legal advice.