Consumer Compliance Outlook: Second Quarter 2009

Escrow Accounting Rules: Are You in Compliance?

Because of two recent amendments to Regulations X and Z, compliance with the escrow accounting requirements for mortgage loans will likely become an important issue for financial institutions and consumers. This article reviews the amendments, highlights some compliance issues for escrow statements, and discusses best practices.


In November 2008, the Department of Housing and Urban Development (HUD) announced a final rule amending Regulation X, the implementing regulation for the Real Estate Settlement Procedures Act (RESPA).1 The amendments include a revised three-page good faith estimate (GFE) form that requires lenders to disclose whether borrowers must maintain an escrow account for the loan. The effective date for the revised GFE is January 1, 2010. The portion of the revised form that pertains to maintaining escrow accounts is shown below.

The final rule also includes a minor technical change to §3500.17(b) External Link of Regulation X concerning the escrow accounting provisions of the rule. The amendment eliminates definitions used for the phase-in period for a prior escrow accounting change from single-item accounting to aggregate accounting.

A more significant regulatory change affecting escrow compliance is the July 2008 amendments to Regulation Z, the implementing regulation for the Truth in Lending Act. The Board amended the regulation in response to the mortgage crisis, using its rulemaking authority under the Home Ownership and Equity Protection Act of 1994 (HOEPA). One amendment addresses the concern that some lenders misled borrowers about the affordability of the monthly mortgage payment by not requiring an escrow account for property taxes and insurance. This practice enabled lenders to quote a lower monthly payment to borrowers relative to competing lenders who did require escrow accounts. Many borrowers shop for mortgages based on the monthly payment, which they rely on to determine if they can afford a mortgage. Mortgages without escrow accounts created problems for some borrowers who were surprised to learn later that the mortgage payment did not include an escrow account for property taxes and insurance.

HUD's Revised GFE Disclosures for Escrow Accounts
Escrow account information

Some lenders require an escrow account to hold funds for paying property taxes or other property-related charges in addition to your monthly amount owed of $

Do we require you to have an escrow account for your loan?

No, you do not have an escrow account. You must pay these charges directly when due.

Yes, you have an escrow account. It may or may not cover all of these charges. Ask us.

To address this problem, §226.35(b)(3) External Link of the amended Regulation Z requires escrow accounts for all "higher-priced" first-lien mortgages secured by a borrower's principal dwelling.2 A loan qualifies as higher priced if it is a consumer-purpose loan secured by a consumer's principal dwelling with an annual percentage rate that exceeds the average prime offer rate for a comparable transaction as of the date the interest rate is set by 1.5 points for first-lien loans or 3.5 points for subordinate lien loans.3 After the first year, a borrower can ask the lender to opt out of the escrow account, but the lender has the right to reject the request. The effective date for the HOEPA escrow requirements is April 1, 2010, with an extension to October 1, 2010 for manufactured homes.

Financial institutions offering loans qualifying as higher-priced mortgage loans will be required to provide escrow accounts for those loans. Setting up the systems and infrastructure necessary to collect and administer escrow accounts will present challenges for financial institutions planning to make higher-cost loans after the final rule's effective date.


Because of the impending changes to the escrow rules, a review of frequent escrow compliance issues is in order, including the following: understanding escrow accounting methods, preparing escrow disclosure statements and determining escrow deposit amounts, and ensuring that annual analyses result in correct account balances.

Escrow Accounting Methods

When establishing and maintaining escrow accounts, financial institutions must do the following:

  • Conduct an escrow account analysis, before establishing an escrow account, to determine the amount the borrower must deposit into the escrow account at inception and the amount of the borrower's periodic payments into the escrow account;
  • Prepare and deliver an initial escrow account statement to the borrower;
  • Conduct an escrow account analysis at the completion of each escrow account computation year to determine the borrower's monthly escrow account payments for the next computation year;
  • Use the initial and annual escrow account analyses to determine whether a surplus, shortage, or deficiency exists and adjust the account; and
  • Prepare and submit an annual escrow account statement to the borrower.

These escrow tasks must be conducted in accordance with the accounting rules outlined in §3500.17 of Regulation X. In addition, the regulation contains rules and limitations with regard to the amounts that may be held in escrow accounts as well as specific requirements for the contents of the initial and annual statements. Of particular note is the requirement in §3500.17(c)(4) that lenders conduct an aggregate analysis rather than a single-item analysis when conducting the account analysis. A single-item analysis accounts for each escrow item separately, while an aggregate analysis considers the account as a whole to compute the sufficiency of escrow account funds.4 The latter rule has engendered confusion resulting in incorrect amounts being held in escrow accounts.

Initial Escrow Account Analysis and Disclosure

The initial escrow account analysis and disclosure statement set the foundation for the escrow account. Therefore, it is important to consider the following when establishing the account:

Initial Escrow Account Analysis. Compliance with aggregate accounting rules is necessary to accurately calculate the required escrow amounts. Errors can result from a combination of overreliance on automated systems to perform the required calculations and staff not sufficiently versed in the rules. Examples of specific causes include:

  • Relying unduly on automated systems without periodic testing to ensure that the system is operating correctly;
  • Lacking an understanding of the limitations of these automated systems;
  • Having system defaults that do not match the institution's actual practice;
  • Making manual overrides or alterations to automated systems inconsistent with the institution's actual practices; and
  • Failing to adequately train staff regarding the differences between single-item and aggregate analysis and when the different analyses can or must be used.

Initial Escrow Account Statements. Errors in the initial analysis can lead to incorrect initial escrow account statements. Errors on these statements can also occur because of discrepancies between the escrow analysis and the initial escrow disclosure statement or amounts on the HUD-1 settlement statement (HUD-1). Common errors include:

  • Failing to include flood insurance premiums in required escrow accounts;
  • Disclosing amounts on the initial escrow statement different from those amounts collected at closing for the initial escrow deposit;
  • Collecting lesser amounts of individual escrow line items to reduce the amount of the aggregate adjustment on the HUD-1; and
  • Failing to disclose the aggregate adjustment on the HUD-1.

Initial Escrow Deposits. Overcharges in the collection of initial escrow deposits generally result when errors are made in the initial analysis. Other calculation or system entry errors can result in errors in the escrow deposit amounts. Some examples include:

  • Using incorrect cushion amounts in excess of the regulatory limitations;
  • Collecting excess funds when a property tax installment is paid at settlement;
  • Including mortgage insurance (MI) premiums in cushion amounts when MI premiums are paid monthly; and
  • Rounding adjustments to create an even dollar amount.

Annual Escrow Account Analysis and Statement

Errors in the annual account analysis can lead to incorrect calculations, which often result in incorrect surplus, shortage, or deficiency amounts. Some typical causes include:

  • Using incorrect disbursement dates in projecting activity for the next year (e.g., changing the dates of projected disbursements can result in account balance projections that are incorrect);
  • Projecting surpluses, shortages, or deficiencies based on incorrect account balances;
  • Maintaining incorrect cushion amounts in excess of regulatory requirements or lower limitations placed in mortgage loan documents; and
  • Failing to refund borrower(s) surplus amounts in excess of $50, as required by §3500.17(f)(2) of Regulation X.

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

  • The reason the projected low balance (i.e., cushion) was not reached;
  • The total amounts paid into and out of the escrow account in the previous year; and
  • One or more estimated payments or disbursements missing from the account analysis.


If your institution currently offers escrow accounts, review your escrow accounting systems and disclosures to ensure compliance with the requirements of §3500.17 of Regulation X. If your institution will be required to offer escrow accounts under the new rules, you should begin planning now. Significant system changes, disclosure forms, and training are required. Revisions to policies, procedures, and controls will also be necessary. Analyzing the escrow accounting issues discussed in this article and their causes as you begin this process will help ensure that you do not make the same mistakes. Lenders holding or servicing loans with escrow accounts may also want to consider the following best practices:

  • Understand the differences between single-item and aggregate analyses. This distinction is a key factor in complying with the escrow accounting requirements.
  • Conduct regular staff training on escrow requirements. Include training on the proper usage of the software platform used to generate escrow account disclosures.
  • Perform periodic system testing to ensure systems are accurately performing escrow account analyses.
  • Review mortgage loan documents for wording regarding cushion limits and ensure that systems comply with either the regulatory or the contractual cushion limitations, whichever are lower.
  • Develop policies and procedures for escrow account requirements.
  • Conduct periodic compliance reviews and audits that include escrow accounting as well as escrow account statements.


The potential impact on consumers and the associated risks to lenders make compliance with the requirements for initial and annual escrow account statements particularly important. While this article does not exhaustively address all of the complexities of the escrow accounting rules, it discusses aspects of the requirements of the recent RESPA changes, the Regulation Z amendments, and best practices to help institutions achieve compliance. Specific issues and questions should be raised with the consumer compliance contact at your Reserve Bank or with your primary regulator.

  • 1 HUD issued the final rules on November 12, 2008; go to the HUD website External Site. The Federal Register notice is available on the GPO website External Site.
  • 2 The Board issued the rules on July 14, 2008; go to the Board of Governors website. The Federal Register notice is available on the GPO website External Site. The Fourth Quarter 2008 issue of Outlook contained a detailed article about the recent Regulation Z changes.
  • 3 Higher-priced mortgage loans do not include loans for second homes or investment properties, short-term construction loans, or home equity lines of credit. The Federal Financial Institutions Examination Council (FFIEC) publishes current average prime offer rates on its website External Site along with a rate spread calculator to determine if a loan qualifies as higher priced.
  • 4 For more information on aggregate analysis, refer to §3500.17(d) External Site of Regulation X, as amended, the examples in Exhibit E, and the public guidance information on the HUD's website External Site.