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BULLETIN: 503-95-0510

DATE: May 10, 1995

SUBJECT: New aggregate escrow accounting regulations

This bulletin addresses settlement agents' preparation of HUD-1 or HUD-1A Settlement Statements in compliance with HUD's final Rules establishing new escrow accounting procedures under Sections 6(g) and 10 of the Real Estate Settlement Procedures Act of 1974 (RESPA).

The Rules (together, a final rule published October 26, 1994 and a subsequent final rule published February 15, 1995) are effective May 24, 1995 and establish new aggregate escrow accounting requirements for all escrow accounts established on or after May 24, 1995 on all federally related mortgages, as defined in RESPA.

Prior to adoption of the Rules, a single-item accounting analysis was used by servicers in accordance with Section 10(a) (1) of RESPA. The HUD-1 Settlement Statement Series 1000 RESERVES DEPOSITED WITH LENDER was used for this purpose, and monthly payments and a cushion were allocated on an item by item basis. With the adoption of aggregate analysis, all payments for all items are lumped together so that the escrow account will contain sufficient funds to meet payment obligations as they become due, together with a two-month cushion that cannot exceed one-sixth of the total annual estimated payments from the escrow account. Escrow accounts are defined in the Regulations as accounts established or controlled on behalf of the borrower to pay taxes, insurance and other charges. The accounts may be required by the lender or voluntarily agreed to by the borrower.

PHASE-IN. Aggregate accounting Rules are effective May 24, 1995 for escrow accounts established on or after that date. For accounts existing before that date, the Rules provide for an approximately 3-year phase-in period to be implemented by the servicer. For all accounts, the servicer shall perform an annual escrow account analysis to analyze if the account balances are adequate, and give results of the accounting to the borrower.

During the phase-in period, an alternative procedure is available. The settlement agent may initially calculate the 1000 series deposits for the HUD-1 and HUD-1A settlement statement using single-item analysis with only a one-month cushion (unless the mortgage loan documents indicate a smaller amount). In the escrow account analysis conducted within 45 days of settlement, however, the servicer shall adjust the escrow account to reflect the aggregate accounting balance. This option is available only where aggregate accounting is not performed as part of the closing process.

HUD-1 OR HUD-1A PREPARATION. The settlement agent (or servicer) first itemizes individual deposits in the 1000 series of the HUD-1 or HUD-1A settlement statement using single-item accounting. The settlement agent then does an aggregate analysis which in most cases will produce a lower required deposit. The difference in the required deposits using the two methods is an adjustment figure to be entered on the last line of the 1000 series. The adjustment will always be either a negative number or zero (-0-). An adjustment is necessary because lenders may collect more money under a single-item analysis accounting than under aggregate analysis accounting. Appendix A to Part 3500 explains this in detail and is reproduced later in this Bulletin.

The settlement agent is therefore showing entries for Lines 1000-1008 in the example below using a single-line analysis with a cushion, and then determining the difference between that analysis and the result of aggregate analysis with a cushion. The result is the adjustment (often a negative number); in some cases there is no difference. Appendix F to Part 3500 illustrates both methods of analysis and is reproduced later in this Bulletin. Using the example in Appendix F, the 1000 series would look like this:

The -$90.00 adjustment is the difference between the $1,130.00 deposit required using single-item analysis and the $1,040.00 deposit required using aggregate analysis.

INITIAL ESCROW ACCOUNT ANALYSIS AND INITIAL ESCROW ACCOUNT

STATEMENTS. An initial escrow account statement refers to the first disclosure statement that the servicer delivers to the borrower at or within 45 calendar days of settlement, and may be incorporated into the HUD-1 or HUD-1A settlement statement or as a separate document.

The Initial Escrow Account Statement contains a running balance, starting with a starting balance, and must identify the cushion. Presumably the amounts paid in each month are the same. HUD expects these will be prepared by the servicer of the loan, rather than a settlement agent. Time will tell.

Appendices G-1 and G-2 to Part 3500 illustrate the content of the Initial Escrow Account Statement (both in blank and filled-out formats), and is reproduced at the end of this Bulletin.

Please note that the Appendices to Part 3500 and the accompanying Regulations contain examples and discussion of Initial Escrow Account Disclosure Statements for use in BIWEEKLY ACCOUNTING and THREE YEAR CYCLES that are not discussed in this Bulletin, since loans employing those methods typically do not require escrow accounts.

The following are the relevant portions of the Rules and Regulations reproduced for the settlement agents' information. Complete copies of the 61 published pages of Rules and Regulations are available upon request.

Section 3500.17(g) describes the initial escrow account statement: (g) Initial Escrow Account Statement. (1) Submission at settlement, or within 45 calendar days of settlement. As noted in § 3500.17(c)(2), the servicer shall conduct an escrow account analysis before establishing an escrow account to determine the amount the borrower shall deposit into the escrow account, subject to the limitations of § 3500.17(c)(1)(i). After conducting the escrow account analysis for each escrow account, the servicer shall submit an initial escrow account statement to the borrower at settlement or within 45 calendar days of settlement for escrow accounts that are established as a condition of the loan.

(i) The initial escrow account statement shall include the amount of the borrower's monthly mortgage payment and the portion of the monthly payment going into the escrow account and shall itemize the estimated taxes, insurance premiums, and other charges that the servicer reasonably anticipates to be paid from the escrow account during the escrow account computation year and the anticipated disbursement dates of those charges. The initial escrow account statement shall indicate the amount that the servicer selects as a cushion. The statement shall include a trial running balance for the account.

(ii) Pursuant to § 3500.17(h)(2), the servicer may incorporate the initial escrow account statement into the HUD-1 or HUD-1A settlement statement. If the servicer does not incorporate the initial escrow account statement into the HUD-1 or HUD-1A settlement statement, then the servicer shall submit the initial escrow account statement to the borrower as a separate document.

(2) Time of submission of initial escrow account statement for an escrow account established after settlement. For escrow accounts established after settlement (and which are not a condition of the loan), a servicer shall submit an initial escrow account statement to a borrower within 45 calendar days of the date of establishment of the escrow account.

(h) Format for initial escrow account statement. (1) The format and a completed example for an initial escrow account statement is set out in Appendix G of this part.

(2) Incorporation of Initial Escrow Account Statement Into HUD-1 or HUD-1A Settlement Statement.

Pursuant to § 3500.9(a)(11), a servicer may add the initial escrow account statement to the HUD-1 or HUD-1A settlement statement. The servicer may include the initial escrow account statement in the basic text or may attach the initial escrow account statement as an additional page to the HUD-1 or HUD-1A settlement statement.

(3) Identification of Payees. The initial escrow account statement need not identify a specific payee by name if it provides sufficient information to identify the use of the funds. For example, appropriate entries include: county taxes, hazard insurance, condominium dues, etc. If a particular payee, such as a taxing body, receives more than one payment during the escrow account computation year, the statement shall indicate each payment and disbursement date. If there are several taxing authorities or insurers, the statement shall identify each taxing body or insurer (e.g., "City Taxes", "School Taxes", "Hazard Insurance", or "Flood Insurance", etc.).

Section 3500.17(c) (1) (i) of the Regulations places a limit on the amount a servicer may charge the borrower initially to deposit into an escrow account:

(c) Limits on payments to escrow accounts; acceptable accounting methods to determine limits.

(1) A lender or servicer (hereafter servicer) shall not require a borrower to deposit into any escrow account, created in connection with a federally related mortgage loan, more than the following amounts:

(i) Charges at settlement or upon creation of an escrow account. At the time a servicer creates an escrow account for a borrower, the servicer may charge the borrower an amount sufficient to pay the charges respecting the mortgaged property, such as taxes and insurance, which are attributable to the period from the date such payment(s) were last paid until the initial payment date. In addition, the servicer may charge the borrower a cushion that shall be no greater than one-sixth (1/6) of the estimated total annual payments from the escrow account. The "amount sufficient to pay" is computed so that the lowest month end target balance projected for the escrow account computation year is zero (-0-) (see Step 2 in Appendix F).

Before the account is established, the servicer must determine the amount to be deposited, subject to the above limit, by conducting an "escrow account analysis" according to § 3500.17(c)(2) of the Regulations:

(2) Escrow analysis at creation of escrow account. Before establishing an escrow account, the servicer shall conduct an escrow account analysis to determine the amount the borrower shall deposit into the escrow account, subject to the limitations of § 3500.17(c)(1)(i) and the amount of the borrower's periodic payments into the escrow account, subject to the limitations of § 3500.17(c)(1)(ii). In conducting the escrow account analysis, the servicer shall estimate the disbursement amounts according to § 3500.17(c)(7). Pursuant to 3500.17(k), 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 as the disbursement date for the escrow item. Upon completing the initial escrow account analysis, the servicer shall prepare and deliver an initial escrow account statement to the borrower, as set forth in § 3500.17(g). The servicer shall use the escrow account analysis to determine whether a surplus, shortage or deficiency exists since settlement and shall make any adjustments to the account pursuant to § 3500.17(f).

Section 3500.17(d) of the Regulations sets out steps to follow for escrow account analysis:

(d) Methods of escrow account analysis. Paragraph (c) of this section prescribes acceptable accounting methods. The following sets forth the steps servicers shall use to determine whether their use of an acceptable accounting method conforms with the limitations in § 3500.17(c)(1). The steps set forth in this section derive maximum limits. Servicers may use accounting procedures that result in lower target balances. In particular, servicers may use a cushion less than the permissible cushion or no cushion at all. This section does not require the use of a cushion.

(1) Aggregate analysis. (i) When a servicer uses aggregate analysis in conducting the escrow account analysis, the target balances may not exceed the balances computed according to the following arithmetic operations:

(A) The servicer first projects trial balance for the account as a whole over the next computation year (a trial running balance). In doing so the servicer assumes that it will make estimated disbursements on or before the earlier of the deadline to take advantage of discounts, if available, or the deadline to avoid a penalty. The servicer does not use pre-accrual on these disbursement dates. The servicer also assumes that the borrower will make monthly payments equal to one-twelfth of the estimated total annual escrow account disbursements.

(B) The servicer then examines the monthly trial balances and adds to the first monthly balance an amount just sufficient to bring the lowest monthly trial balance to zero, and adjusts all other monthly balances accordingly.

(C) The servicer then adds to the monthly balances the permissible cushion. The cushion is two months of the borrower's escrow payments to the servicer or a lesser amount specified by State law or the mortgage document (net of any increases or decreases because of prior year shortages or surpluses, respectively).

(ii) Lowest monthly balance. Under aggregate analysis, the lowest monthly target balance for the account shall be less than or equal to one-sixth of the estimated total annual escrow account disbursements or a lesser amount specified by State law or the mortgage document. The target balances that the servicer derives using these steps yield the maximum limit for the escrow account. Appendix F to this part illustrates these steps.

(2) Single-item or other non-aggregate analysis method. (i) When a servicer uses single-item analysis or any hybrid accounting method in conducting an escrow account analysis during the phase-in period, the target balances may not exceed the balances computed according to the following arithmetic operations:

(A) The servicer first projects a trial balance for each item over the next computation year (a trial running balance). In doing so the servicer assumes that it will make estimated disbursements on or before the earlier of the deadline to take advantage of discounts, if available, or the deadline to avoid a penalty. The servicer does not use pre-accrual on these disbursement dates. The servicer also assumes that the borrower will make periodic payments equal to one-twelfth of the estimated total annual escrow account disbursements.

(B) The servicer then examines the monthly service balance for each escrow account item and adds to the first monthly balance for each separate item an amount just sufficient to bring the lowest monthly trial balance for that item to zero, and then adjusts all other monthly balances accordingly.

(C) The servicer then adds the permissible cushion if any, to the monthly balance for the separate escrow account item. The permissible cushion is two months of escrow payments for the escrow account item (net of any increases or decreases because of prior year shortages or surpluses, respectively) or a lesser amount specified by State law or the mortgage document.

(D) The servicer then examines the balances for each item to make certain that the lowest monthly balance for that item is less than or equal to one-sixth of the estimated total annual escrow account disbursements for that item or a lesser amount specified by State law or the mortgage document.

(ii) In performing an escrow account analysis using single-item analysis, servicers may account for each escrow account item separately, but servicers shall not further divide accounts into sub-accounts, even if the payee of a disbursement requires installment payments. The target balances that the servicer derives using these steps yield the maximum limit for the escrow account. Appendix F to this part illustrates these steps.

Appendix A to Part 3500-Instructions for Completing HUD-1 and HUD-1A Settlement Statements:

Line Item Instructions:

Lines 1000-1008.

After itemizing individual deposits in the 1000 series using single-item accounting, the servicer shall make an adjustment based on aggregate accounting. This adjustment equals the difference between the deposit required under aggregate accounting and the sum of the deposits required under single-item accounting. The computation steps for both accounting methods are set out in § 3500.17(d). The adjustment will always be a negative number or zero (-0-). The settlement agent shall enter the aggregate adjustment amount on a final line in the 1000 series of the HUD-1 or HUD-1A statement.

During the phase-in period, as defined in § 3500.17(b), an alternative procedure is available. If a servicer has not yet conducted the escrow account analysis to determine the aggregate accounting starting balance, the settlement agent may initially calculate the 1000 series deposits for the HUD-1 and HUD-1A settlement statement using single-item analysis with a one-month cushion (unless the mortgage loan documents indicate a smaller amount). In the escrow account analysis conducted within 45 days of settlement, the servicer shall adjust the escrow account to reflect the aggregate accounting balance.

Please do not hesitate to send us an e-mail (info@ruthtechnology.com) if you have questions, comments or if you come across something that would contribute to this section.