3214 Federal Register / Vol. 63, No. 13 / Wednesday, January 21, 1998 / Rules and Regulations

1The 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).

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.).

DEPARTMENT OF HOUSING AND

URBAN DEVELOPMENT

24 CFR Part 3500

[Docket No. FR–4079–F–02]

RIN 2502–AG75

Amendments to Real Estate Settlement

Procedures Act Regulation (Regulation

X)—Escrow Accounting Procedures

AGENCY: Office of the Assistant

Secretary for Housing-Federal Housing

Commissioner, HUD.

ACTION: Final rule.

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.

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.

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
Federal Register / Vol. 63, No. 13 / Wednesday, January 21, 1998 / Rules and Regulations 3215

3As 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.

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 (onesixth 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 onesixth 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.

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.’’
3216 Federal Register / Vol. 63, No. 13 / Wednesday, January 21, 1998 / Rules and Regulations

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 leadbased 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

§§ 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 halfyear’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
Federal Register / Vol. 63, No. 13 / Wednesday, January 21, 1998 / Rules and Regulations 3217

4The 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.

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

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
3218 Federal Register / Vol. 63, No. 13 / Wednesday, January 21, 1998 / Rules and Regulations

5Three 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.

6The 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).

7The 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.

8The 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.

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.

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 §§ 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.

However, the Department’s existing

regulations (§ 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.

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
Federal Register / Vol. 63, No. 13 / Wednesday, January 21, 1998 / Rules and Regulations 3219

9The 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.

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 consumerfriendly 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

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
3220 Federal Register / Vol. 63, No. 13 / Wednesday, January 21, 1998 / Rules and Regulations

10Seven 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.

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.

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 SingleItem 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 leadbased 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 LeadBased 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 leadbased 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.

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.

B. What Commenters Commented On

The Annual vs. Installment

Disbursements problem attracted the

most comments. One-hundred twentyeight 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
Federal Register / Vol. 63, No. 13 / Wednesday, January 21, 1998 / Rules and Regulations 3221

12The assumptions are that if, for example, the

entire tax bill is paid on January 1, the discount

Continued

sixteen commenters, including ninetysix originators/servicers and all but two

of the trade associations. The SingleItem 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
3222 Federal Register / Vol. 63, No. 13 / Wednesday, January 21, 1998 / Rules and Regulations

applies to the entire bill. Otherwise, half of the bill

is due on January 1 and half is due on July 1.

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.

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.

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.

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,
Federal Register / Vol. 63, No. 13 / Wednesday, January 21, 1998 / Rules and Regulations 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
3224 Federal Register / Vol. 63, No. 13 / Wednesday, January 21, 1998 / Rules and Regulations

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—
Federal Register / Vol. 63, No. 13 / Wednesday, January 21, 1998 / Rules and Regulations 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
3226 Federal Register / Vol. 63, No. 13 / Wednesday, January 21, 1998 / Rules and Regulations

14The caveat, ‘‘by RESPA,’’ is designed to allow

for the possibility that State law could require

annual disbursements.

15For 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.

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

§ 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 § 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

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.
Federal Register / Vol. 63, No. 13 / Wednesday, January 21, 1998 / Rules and Regulations 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 onetime 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
3228 Federal Register / Vol. 63, No. 13 / Wednesday, January 21, 1998 / Rules and Regulations

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
Federal Register / Vol. 63, No. 13 / Wednesday, January 21, 1998 / Rules and Regulations 3229

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

(§ 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 shortyear 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 opposed the alternative because it

would not address the payment shock

problem and/or ignored that a problem

exists. There were 13 commenters who

made such a statement—10 originators/

servicers (including 1 of the 4

mentioned above), 1 trade association, 1

tax service, and the home builder

mentioned above.

Countrywide commented that

payment shock is the most serious

problem caused by the existing escrow

accounting regulations because it leads

to delinquency, hurts borrowers’ credit,

and may result in people losing their

homes. NationsBank commented that it

results in an inability to make

additional payments in the second year,

increases the possibility of delinquent

payments, and accelerated collection

proceedings, and causes consumers to

lose confidence in their lending

institutions. Two other originators/

servicers agreed with Countrywide’s

assessment that the situation leads to a

significant number of defaults and

foreclosures. Two commenters

commented that when payment shock
3230 Federal Register / Vol. 63, No. 13 / Wednesday, January 21, 1998 / Rules and Regulations

occurs, borrowers unfairly blame their

lenders and/or their builders and

closing agents. Two commenters

commented that when it happens,

lenders are left having to carry

shortages, sometimes for 24 to 48

months, and that this puts the lenders

at risk. Countrywide indicated that it is

a particularly perilous situation when

two or more risk factors are present in

a transaction (a condition known as

‘‘layered risk’’), such as when payment

shock is combined with an upward

adjustment in the ARM rate.

In contrast, seven originators/

servicers questioned whether payment

shock was really a problem in need of

fixing. A bank with a mortgage lending

subsidiary commented that while many

consumers fail to plan for payment

shock, they are not really surprised by

it and feel that the problem has nothing

to do with the servicer. A rural bank

commented that it is really a consumer

education problem, a problem that will

happen regardless of whether there is an

escrow account or not. A bank holding

company commented that it is not a

significant problem, while a federal

credit union indicated it was a very

infrequent problem. One servicer

requested that the Department wait until

the transition period expires on the

1994–1995 escrow rules before making

any further changes. Citicorp also

questioned whether it is a real and ongoing problem and suggested waiting

until 1998 to consider new

requirements.

1. Comments on Consumer Choice

Only one commenter, the California

Association of Realtors (CAR),

supported Consumer Choice. As with

the Annual vs. Installment

Disbursements problem, the CAR

commented 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.

In contrast, 81 commenters opposed

the adoption of Consumer Choice—66

originators/servicers, 10 trade

associations, 1 tax service, 2 financial

software companies, 1 builder, and 1

person of unknown professional

interest. The most common reasons

given included:

1. It would result in miscellaneous

costs and/or administrative burdens

(e.g., would increase cost of servicing or

be a burden on closing, would create

operational problems, would be

complicated) (53 commenters—46

originators/servicers, 5 trade

associations, 1 financial software

company, 1 builder).

2. It would be impractical (36

commenters), for reasons such as

servicers will not have or would find it

difficult to get or estimate the

information needed to calculate the

disclosure (30 commenters—28

originators/servicers, 2 financial

software companies).

3. It would necessitate more customer

service to explain choices and answer

questions for consumers (28

commenters—26 originators/servicers, 2

trade associations).

4. Consumer Choice would require

system and programming changes and

new software or additional

programming (23 commenters—19

originators/servicers, 4 trade

associations). Two large lenders

indicated that if Consumer Choice were

selected they would need in excess of

18 to 24 months from the issuance of the

final rule to reprogram their computers

and develop new forms and procedures.

5. The specific costs and burdens of

consumer disclosure, including

producing and mailing disclosures,

soliciting preferences, processing

disclosures, tracking selections, and

maintaining information on selection

should be avoided (19 commenters—12

originators/servicers, 6 trade

associations, 2 financial software

companies) or objections to adding a

new disclosure in general (5

commenters—4 originators/servicers, 1

builder).

6. The additional cost would be

passed on to consumers (21

commenters—16 originators/servicers, 3

trade associations, 1 financial software

company, 1 builder).

7. It would create consumer

confusion, consumers would not be able

to make an educated selection, and it

would impose a burden on consumers

to have to make such a choice (17

commenters—11 originators/servicers, 4

trade associations, 1 financial software

company, 1 builder).

8. There is no need for it (14

commenters) for reasons such that no

consumer benefit or no significant

consumer benefit would result (10

commenters—6 originators/servicers, 4

trade associations).

9. It would necessitate multiple sets of

closing documents to accommodate

possible choices or otherwise interfere

with the correct preparation of closing

documents (eight commenters—five

originators/servicers, one trade

association, one financial software

company, one builder).

10. Additional training of staff would

be required (eight commenters—six

originators/servicers, two trade

associations).

Several commenters commented

specifically about the proposed

prohibition against servicers switching

accounting methods without the

borrower’s consent, which was one

element of the Consumer Choice

alternative. Only one commenter, GE

Capital, indicated that it supported

restricting changes to accounting

methods when there is a transfer of

servicing. GE Capital’s support,

however, was conditioned on the

selection of the accounting method

being limited to a one-time choice at

closing, the selection being limited to

situations involving new construction,

and the regulations being clarified to

provide that payments (as opposed to

methodology) could be changed in the

event of unanticipated changes to

escrow items.

In contrast, seven commenters,

including six originators/servicers and

one trade association, opposed the

aspect of Consumer Choice prohibiting

servicers from switching escrow

accounting methods. The reasons given

included the following: (1) It would

chill or burden sales of servicing rights

(three originators/servicers, one trade

association); (2) it would pose an

administrative burden (two originators/

servicers); and (3) it would impair value

of servicing rights (two originators/

servicers).

In the proposed rule, the Department

asked Question 2, which was designed

to elicit commenters’ views on how to

define a substantial increase in

disbursements from an escrow account,

and how mortgage servicers could go

about determining whether bills paid

out of escrow accounts were expected to

increase substantially after the first year.

Virtually all of the commenters that

responded to this question focused on

whether a 50 percent increase was an

appropriate threshold for defining a

substantial increase, as proposed.

Four commenters—three originators/

servicers and one trade association—

supported using 50 percent as a

threshold. One bank holding company

indicated that 50 percent was an

appropriate threshold but that the

payment shock problem should only be

addressed in situations involving new

construction. Most gave no reason for

why they believed 50 percent was an

appropriate threshold, other than that it

seemed to be a reasonable approach.

The National Association of Federal

Credit Unions (NAFCU) indicated that

the approach would avoid confusion.

In contrast, 21 commenters—17

originators/servicers, 2 trade

associations, 1 financial software
Federal Register / Vol. 63, No. 13 / Wednesday, January 21, 1998 / Rules and Regulations 3231

company, and 1 builder—opposed using

50 percent as a threshold. Many of these

commenters indicated that the

Department should not set any

threshold for when an increase would

be considered substantial, yet no

commenters favored offering

alternatives to borrowers whose escrow

payments were not expected to increase

substantially after the first year, and 16

commenters (14 originators/servicers, 2

trade associations) specifically opposed

such an idea. The reasons for opposing

using 50 percent as a threshold and/or

opposing any Department-established

threshold were similar. They included:

1. Servicers would not be able to

estimate if the expected increase was

within the threshold (seven comments—

six originators/servicers, one trade

association).

2. Even less than a 50 percent increase

could be a problem for borrowers (five

commenters—three originators/

servicers, one financial software

company, one builder).

3. It would be burdensome and/or

costly to calculate if the expected

increase would meet the threshold (five

commenters—four originators/servicers,

one trade association).

4. Servicers should be given more

flexibility (two originators/servicers).

The Department also asked Questions

2 and 7, which were designed to elicit

responses as to whether, if the

Consumer Choice alternative were

adopted, the final rule should limit a

borrower’s opportunity to switch escrow

accounting methods. Sixteen

commenters (14 originators/servicers, 1

trade association, 1 financial software

company) indicated that they opposed

allowing even a one-time choice to be

provided to consumers, but that if the

Department chose the Consumer Choice

alternative anyway, it should be limited

to a one-time choice, for reasons such as

the additional burdens and costs more

opportunities to switch would create.

Several other commenters that were less

clear in their dislike of the Consumer

Choice alternative, nonetheless took

clear positions against offering more

than a one-time choice.

In contrast, only three commenters

advised against having different systems

for different borrowers. One based its

view on the additional confusion it

would create over options and

management of the options. Another

based its opinion on the additional

complications. A third stated it would

add to the programming, personal, and

postage costs and create more

confusion.

2. Comments on Make No Change

Alternative

A total of 46 commenters supported

the Make No Change alternative. Fortytwo commenters—35 originators/

servicers, 5 trade associations, 1

financial software company, and 1

person of unknown professional

interest—supported Make No Change as

proposed. The MBA and a bank and

trust indicated that Make No Change

was their second choice next to

Mandate First Year Overpayment;

NAFCU also implied it was their second

choice.

Four additional commenters indicated

they would support Make No Change if

Variation (A) were added to it. The

proposed rule described Variation (A) as

follows:

(A) Require servicers to disclose to

borrowers that it is anticipated that they will

have a substantial payment increase in the

second year, so borrowers will be less

surprised when such an increase occurs, but

do not require servicers to indicate

specifically to borrowers methods of avoiding

the shortage.

61 FR 46517.

Three of the 42 who supported the

Make No Change alternative as

proposed also indicated they would

support Make No Change with Variation

(A). In addition, two originators/

servicers that recommended alternatives

instead of Make No Change also

indicated that as part of those

approaches that it should be disclosed

to the borrower that a shortage is

expected, but not the amount of the

expected shortage.

One commenter who otherwise

supported the Make No Change

alternative indicated that it was

opposed to mandating any type of

notice, but indicated a notice similar to

Variation (A) would be less problematic

than the type of disclosure that would

be part of the Consumer Choice

alternative. The commenter observed

that any disclosure should be generic

(no calculations) and advise consumers

that: (1) The amount of taxes for which

escrow funds are being collected is

based on information available at time

of closing about anticipated property

taxes for next year; (2) the amount could

change especially for new construction;

and (3) the consumer should monitor

the situation and consult a tax advisor

if the amount increases substantially.

Ten other commenters—eight

originators/servicers, one financial

software company, one builder—

specifically commented that they

opposed Variation (A). The primary

reasons were that it would not be

effective at eliminating payment shock,

and giving borrowers advance notice

that a payment increase may occur

should be left to the originator/servicer.

The reasons the commenters gave for

supporting the Make No Change

alternative as their second choice were

similar to the reasons other commenters

gave for supporting it as their first

choice. The reasons of all the

commenters who supported it as their

first or second choice are summarized

below:

1. This approach would encourage

good, voluntary practices to help

customers on an individual basis (25

commenters—22 originators/servicers, 3

trade associations).

2. No change is needed because the

current rule is adequate (four

commenters—three originators/

servicers, one financial software

company).

3. It would not be disruptive (three

commenters—two originators/servicers,

one trade association).

4. It would allow servicers to exercise

good judgment (two trade associations).

5. It would be flexible (two

originators/servicers).

6. Providing consumers with a simple

disclosure would give consumers

information to act in their own best

interest (one trade association).

In contrast, 13 commenters—10

originators/servicers, 1 trade

association, 1 tax service, and 1

builder—opposed the Make No Change

alternative. Each of these commenters

stated that they opposed the alternative

because it would not address the

problem and/or ignored a problem that

exists.

Other commenters supported other

variations on the Make No Change

alternative. Two originators/servicers

supported Variation (B). Variation (B)

would have required servicers to

disclose to borrowers that it is

anticipated that they will have a

substantial payment increase in the

second year, and to inform borrowers of

the amount of the expected shortage at

the end of the first year and of the

opportunity to make additional

payments to escrow ahead of schedule

to avoid payment shock. On the other

hand, seven commenters—five

originators/servicers and two financial

software companies—opposed Variation

(B) for reasons such as the burdens and

difficulties associated with trying to

estimate the amount of a shortage that

is expected to result.

In the proposed rule the Department

also solicited comments on the

following alternative. For each new

account for which it is anticipated that

there will be a substantial payment

increase in the second year for one or
3232 Federal Register / Vol. 63, No. 13 / Wednesday, January 21, 1998 / Rules and Regulations

more escrow items, allow the servicer,

with the consent of the borrower, the

option of calculating the escrow

payments on a 24-month basis. This

would allow the servicer to look ahead

to the second year and estimate the

payment that would be due, thereby

mitigating the deficiency or shortage

after the first year, leaving a smaller

deficiency or shortage after the second

year. (Using an escrow account period

of more than 1 year has precedent. See

the treatment of flood insurance and

water purification escrow funds in

§ 3500.17(c)(9).) Under this option,

since the amounts held in escrow would

be greater than allowed under section 10

of RESPA, it would be necessary for the

Secretary to invoke his exemption

authority under section 19(a) of RESPA

(12 U.S.C. 2617).

Only eight commenters commented

on this particular approach. Five

commenters supported it while three

opposed it. The Department does not

believe it is a superior approach to that

adopted in this final rule, as discussed

below.

The proposed rule also invited

commenters to submit other permissible

approaches under RESPA that would

better serve the interests of the public

and the intent of the statute, inviting

commenters to submit specific

regulatory language to implement their

proposals. Fourteen originators/

servicers and two trade associations

submitted a variety of additional

alternatives, none of which appear to

the Department to be a superior

approach to that adopted in this final

rule, as discussed below.

3. Comments on Mandate First Year

Overpayment Alternative

Twenty-seven commenters—21

originators/servicers, 2 trade

associations, 2 financial software

companies, 1 tax service, and 1 State

lending agency—supported the Mandate

First Year Overpayment alternative. In

addition, Citicorp indicated that the

Mandate First Year Overpayment

alternative was its second choice to the

Make No Change alternative. Bank of

America indicated it was its second

choice next to an alternative of its own

creation, but only for new construction

and situations involving special tax

discounts (e.g., reduced taxes for

seniors, disabled, or veterans). GE

Capital indicated it was its second

choice to the Make No Change

alternative, but should only apply if the

increase will be due to taxes being based

on the land value only for the first year.

If the increase will be due to items paid

prior to the first payment date, GE

Capital favored a different approach.

The reasons given for supporting the

Mandate First Year Overpayment

alternative included the following:

1. This approach would avoid

payment shock best and would result in

the fewest shortages (14 commenters—

11 originators/servicers, 2 trade

associations, 1 financial software

company).

2. It would be better for consumers

(12 commenters—9 originators/

servicers, 2 financial software

companies, 1 State lending agency).

3. It would increase consistency,

standardization, and uniformity (seven

commenters—three originators/

servicers, one trade association, two

financial software companies, one State

lending agency).

4. It would require only minimal

changes (four commenters—two

originators/servicers, two financial

software companies).

5. It would be the least costly

alternative to implement (one

originator/servicer, one financial

software company).

6. It would be the fairest alternative

(one originator/servicer, one tax

service).

In contrast, 36 commenters—32

originators/servicers, 3 trade

associations, and 1 person of unknown

professional interest—opposed the

Mandate First Year Overpayment

alternative. The reasons given for

opposing this alternative included the

following:

1. It would not be in the consumer’s

interest to overpay and then money get

back; this would be unfair to the

borrower (10 commenters—7

originators/servicers, 2 trade

associations, 1 person of unknown

professional interest).

2. This alternative would be

administratively burdensome or costly

(e.g., having to make constant refunds

and explanations to consumer) (six

commenters—four originators/servicers,

two trade associations).

3. It would run contrary to the

Secretary’s stated objectives (21

originators/servicers).

In the proposed rule, the Department

proposed that as a variation on Method

C, the cushion could be calculated as

one-sixth of the estimated annual

disbursements for the first year, instead

of 2 months of the escrow payments for

the first year. Two originators/servicers

and a financial software company

indicated that they preferred Method C

to the variation. One of these

commenters, a bank holding company,

indicated that the variation would be far

less effective at eliminating payment

shock, while another, a mortgage

company, indicated the variation would

be more complicated for borrowers and

for the industry. No commenter

indicated a preference for the variation.

Commenters also suggested several

additional variations on the Mandate

First Year Overpayment alternative as

their preferred approach, such as

limiting it only to situations involving

new construction (five commenters—

four originators/servicers, one trade

association) or offering it even when

less than a 50 percent increase in

disbursements were expected (four

commenters—two originators/servicers,

one financial software company, one

builder).

B. Approach Adopted in Today’s Final

Rule

Based on the comments received, the

Secretary has determined that there

would be little value in rulemaking on

the payment shock ‘‘problem.’’ The

comments, in sum, do not indicate that

the ‘‘problem’’ is uniformly accepted as

such in the industry, there is little

support for the Department’s prescribing

a particular accounting method that will

result in overescrowing consumers’

money, and there is no agreement on the

nature of any form that the Department

would prescribe for homebuyers to warn

of the possibility of a substantial

increase in payments to their accounts.

During the rulemaking, however, the

Department identified that individual

servicers do provide a written

disclosure to borrowers when they

anticipate increased payments. The

Department favors this approach and

believes that such a disclosure should

be encouraged as a best practice,

without the Department prescribing the

particular form.

The Department has decided to adopt,

with modifications, the Make No

Change alternative. This final rule,

therefore, continues the current

requirements for escrow analysis, even

when the servicer expects that the

disbursements from the escrow account

will increase substantially after the first

year. This alternative will not prevent

payment shock in all instances. Under

the final rule, however, as in the past,

servicers may disclose the problem to

borrowers, and borrowers may make

voluntary overpayments to escrow

accounts. Servicers may also calculate

short-year statements. Thus, some

methods are available to alleviate the

payment shock problem, although they

are not required.

This final rule does depart, however,

from the Make No Change alternative of

the proposed rule in encouraging, on a

voluntary basis, the use of a consumer

disclosure format concerning payment

shock to be given to consumers when
Federal Register / Vol. 63, No. 13 / Wednesday, January 21, 1998 / Rules and Regulations 3233

the originator or servicer expects that a

substantial increase in escrow payments

will occur in the second year of the

escrow account. The Department has

determined not to define a ‘‘substantial

increase.’’ Instead, this rule leaves this

determination to each originator or

servicer to apply sound business

judgment.

This disclosure format, which is

published as an appendix to this final

rule, will be available from the

Department as a Public Guidance

Document at the address indicated in 24

CFR 3500.3. The format is entitled

‘‘Consumer Disclosure for Voluntary

Escrow Payments’’ to clarify that when

the originator or servicer provides the

disclosure, the consumer may choose

whether to make higher payments

during the first year to reduce or

eliminate the monthly payment increase

in the second year. The disclosure

contains the following information:

The bills paid out of your escrow account

are expected to increase substantially after

the first year[.] [because lllllll].

Under normal escrow practices, your

monthly escrow payment in the second year

could be much higher than in the first.

You may voluntarily choose to make

higher payments during the first year to

reduce or eliminate the monthly payment

increase in the second year. If you are

interested in doing this, contact:

lllllllllllllllllllll

The instructions to the preparer

explain that the blank provided is to

indicate whom to contact for further

information on making voluntary

overpayments during the first year,

including the mailing address, fax

number, e-mail address, and/or

telephone number of the contact. The

terms ‘‘reserve’’ or ‘‘impound’’ may be

substituted for the terms ‘‘escrow

account’’ or ‘‘escrow’’ to reflect local

usage.

While use of the disclosure is not

mandatory, providing the disclosure to

consumers is a best practice that the

Department encourages originators and

servicers to follow. The Department is

publishing this format at the end of this

rule as an appendix for the convenience

of the reader. It will not be codified in

the Code of Federal Regulations.

The recommended format published

with this final rule, in addition to

providing notice that payment shock

may occur, also indicates that payment

shock can be avoided by making

additional payments to the escrow

account, and suggests that the consumer

ask the appropriate originator or

servicer for more information. While

simply informing consumers of the

potential of payment shock and

providing information on how to avoid

it may not lead the consumers to take

actions to avoid it, the information will

benefit some consumers and may lead

them to request voluntary borrower and

servicer agreements to make additional

payments to avoid shortages.

To provide clarity to servicers, this

rule adds a new provision (24 CFR

3500.17(f)(2)(iii)) regarding funds

deposited as a result of such voluntary

borrower and servicer agreements. The

provision states that the voluntary

agreement is for a 1-escrow-accountyear period, although successive

agreements are allowed. By receiving

higher escrow payments into the

account, the ending balance will be

greater, thus lowering or eliminating the

anticipated shortage at the time of the

next analysis. At the time of the next

escrow analysis, § 3500.17(f) regarding

shortages, surpluses, and deficiencies

will continue to apply, and may not be

changed by any voluntary agreement.

C. Basis for Approach Adopted

The comments received served to

confirm that the Make No Change

alternative, with some modifications, is

a workable solution to this problem.

Based on its review of the comments,

the costs and burdens associated with

any other approach are simply too great

compared to the benefits. There is no

strong evidence that additional

regulation is needed at this time to

address the problem. Existing

procedures are adequate to avoid

payment shock. This rule encourages

originators and servicers to inform

consumers of the potential problem and

allow them to use existing procedures to

avoid the problem if they so desire.

This final rule is similar to Variation

(A) of the Make No Change alternative

in the proposed rule, which was

recommended by several commenters.

As recommended by commenters, use of

the format is not mandatory, but the

recommended format is similar to that

which was suggested by several

commenters. Heeding the objections of

several commenters, the recommended

format does not call for an estimate of

the amount of a shortage that is

expected to result. Several commenters

urged that the final rule leave the

decision of whether to give borrowers

advance notice that a payment increase

may occur to the originator/servicer. In

response, this final rule leaves this

determination to each originator or

servicer to apply sound business

judgment in deciding whether to

provide the disclosure; it does not make

the disclosure mandatory or define a

‘‘substantial increase.’’

The Department intends this final rule

to encourage more originators and

servicers to adopt practices that will

ensure that consumers are informed of

the payment shock problem and given

the opportunity to avoid it. These

practices include:

• Notifying borrowers in advance and

providing an opportunity to make

voluntary payments ahead of schedule

to avoid payment shock. The

Department encourages servicers to use

the recommended format published

today to notify borrowers of this

potential problem when the originator

or servicer, in applying sound business

judgment, believes that payment shock

is like to occur.

• Offering consumers extended

repayment plans, even beyond those

required under RESPA, to make up

substantial shortages associated with

payment shock.

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

encourages servicers to adopt these

practices so that they will become more

widespread.

D. Basis for Rejecting Alternative

Approaches

1. Rejection of Consumer Choice

Alternative

While the Department believes it

would have legal authority to impose

Consumer Choice, including the

prohibition against the servicer

changing escrow account methods, as

part of the Secretary’s rulemaking

authority, it has decided not to do so.

The types of costs and burdens

associated with such an approach are

prohibitive at this time.

The Department was also influenced

by the obvious lack of consensus among

the commenters as to how to work out

the technical details associated with the

Consumer Choice alternative. The

Department asked several specific

questions about how to go about

implementing such an alternative in the

way least disruptive to the industry. The

answers 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

concerning this issue do not merit

detailed discussion, but a brief summary

of the comments in response to these

questions is provided below to give a
3234 Federal Register / Vol. 63, No. 13 / Wednesday, January 21, 1998 / Rules and Regulations

sense of the divergent opinions

received:

1. The Department asked Question 5,

which was designed to elicit views 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 nearly

evenly divided on whether the

disclosure should be provided and the

selection made before closing but after

underwriting or before underwriting.

Eight commenters simply indicated

sometime before closing, whereas six

commenters indicated that it would

have to be before underwriting. Two

originators/servicers and one tax service

indicated that no matter what time was

selected, problems would arise. Five

commenters specifically indicated that

the selection would affect underwriting

because it could affect the funds needed

to close, whereas one mortgage lending

subsidiary of a bank stated emphatically

that it ‘‘should have absolutely no

bearing on the loan underwriting or

approval process since the borrower

must qualify based on a tax escrow

payment calculated on fully assessed

value.’’

2. The Department asked Question 6,

which asked whether the Department

should prescribe a disclosure format if

an approach were adopted in which the

borrower’s preference for a particular

escrow accounting method were

controlling. Although there was general

agreement that the Department should

prescribe the format (15 commenters

supporting prescribing it with only 2

opposed), there was disagreement over

what the disclosure should say. One

commenter supported the disclosure the

Department had proposed, agreeing

‘‘with the simplicity of the proposed

format.’’ Seven commenters, however,

said it was confusing and contained too

much information, whereas two

commenters criticized it for not

including enough information.

2. Rejection of Mandate First Year

Overpayment Alternative

While the Mandate First Year

Overpayment alternative was extolled

by some in the industry as the best

solution, there was no consensus even

within the industry for this approach.

Thirty-two originators/servicers and 3

trade associations opposed it, while

only 21 originators/servicers, 2 trade

associations, 2 financial software

companies, 1 tax service, and 1 State

lending agency supported it. The

Department is persuaded that it is

simply not in the consumer’s interest to

mandate overpayment into escrow

accounts, even if consumers ultimately

get the money back. Mandating

escrowing beyond the limitations of the

statute would be unfair to borrowers.

Consumers should not be forced to tie

up money unnecessarily in their escrow

accounts and may prefer to invest the

money elsewhere or use it for other

more pressing purposes. There is no

compelling case for the Department to

exercise its exemption authority for this

purpose. Nor would such an approach

be consistent with the Secretary’s stated

objectives for escrow accounting.

VII. Single-Item Analysis With

Aggregate Adjustment Problem—

Comments Received, Approach

Adopted in This Final Rule, and Basis

A. Comments Received on Revision

Proposed

The Department sought comments

from the public on this proposal, as well

as other approaches that would be

permissible under RESPA and might

better serve the interests of the public

and the intent of the statute. The

Department also invited commenters to

submit specific regulatory language to

implement their proposals.

A significant number of commenters,

including servicers and trade

associations, found the proposal to

represent a functional or acceptable

solution. The MBA, while favoring the

proposal, indicated that some of its

members were concerned about

settlement agent confusion from the

change. Those members opposing the

change indicated that they make use of

the 45-day period within which the

initial analysis must be delivered, so

they did not share the concern over

presenting two different accounting

methods. During the Department’s

development of the proposed rule,

Federal Reserve Board staff had

indicated that it had no objection to the

approach in the proposed rule,

inasmuch as the PMI number for APR

calculations would otherwise be

available.

On the other hand, a number of major

lenders and/or servicers opposed the

change. For example, Chase Mortgage

stated that it was not beneficial for

consumers or servicers, since consumers

would lose the ease of a single statement

from which amounts can be reconciled,

and servicers would have no viable

audit trail to indicate how the initial

deposit was calculated to resolve later

differences or discrepancies. Bank of

America’s comments were similar. A

number of other commenters decried a

retreat from uniformity (the original

premise of the 1994–1995 escrow rules)

that allowing options among servicers

would produce, and indicated that

options affected the ease of servicing

transfers. On a tangential point, the

American Escrow Association wanted

continued clarity that the settlement

agent action reflected instructions

received, not independent activities of

the settlement agent.

B. Approach Adopted in This Final Rule

and Basis

The Department carefully reviewed

the comments and considered them in

view of the mandate issued to the

Department and the Federal Reserve

Board under legislation enacted

September 30, 1996 to re-examine

RESPA and TILA disclosure

requirements. See sec. 2101 of the

Economic Growth and Regulatory

Paperwork Reduction Act of 1996 (Title

II of the Omnibus Consolidated

Appropriations Act, 1997, Pub. L. 104–

208; approved September 30, 1996).

It would be inappropriate to

undertake a piecemeal and unilateral

revision of the HUD–1 and HUD–1A at

this time. In addition, the elimination of

the aggregate adjustment from the HUD–

1 and HUD–1A would harm those who

have already developed systems that

rely on it for an audit trail. There simply

was no consensus for the change.

Therefore, this final rule does not

contain any revision to the 1000 series

disclosures; servicers should continue

to follow existing requirements.

On a related matter, this rule adds

information to the footnote instructions

to Appendix C, in order to reaffirm a

previous clarification that instead of

using aggregate accounting with no

more than a 2-month cushion, the

reserves on the Good Faith Estimate

may be estimated by using single item

accounting with no more than a 1-

month cushion (see 61 FR 46518,

column 3, September 3, 1996).

VIII. Lead-Based Paint Disclosure

Issue—Comments Received, Approach

Adopted in This Final Rule, and Basis

A. Comments Received on Revision

Proposed

Commenters were almost evenly

divided regarding the desirability of

adding the lead-based paint disclosures.

Nine commenters—four originators/

servicers and five trade associations—

indicated that they supported or had no

objection to the proposal. Most gave no

reason. Among those who did, the

National Association of Federal Credit

Unions indicated that they supported

the proposal because it would help

educate borrowers of their rights.

In contrast, eight originators/servicers

opposed the proposal. One lender

indicated that by imposing the burden
Federal Register / Vol. 63, No. 13 / Wednesday, January 21, 1998 / Rules and Regulations 3235

of disclosure on the lender, the

Department would be blurring the

responsibility of sellers to give leadbased paint disclosures required by the

EPA/HUD rule (implementing section

1018 of the Housing and Community

Development Act of 1992). The

commenter noted that lenders have

never been required to disclose matters

of law between sellers and buyers. Six

other originators/servicers presented

similar or related arguments.

Four originators/servicers indicated

that providing a disclosure on the GFE

would be duplicative of other lead

disclosures; one commented that the

HUD booklet ‘‘Settlement Costs and

You’’ was a more appropriate forum for

this type of disclosure. Two originators/

servicers expressed concern that lenders

would become involved in lawsuits

involving lead-based paint, and that the

disclosure could be interpreted as

implying a lender duty in some future

consumer class action.

B. Approach Adopted in This Final Rule

and Basis

Upon careful review of these

comments, the Department agrees with

the commenters who believe that the

lead-based paint disclosure need not

specifically be added to the GFE and the

HUD–1 and HUD–1A as a separate line

at this time. This final rule continues

the existing requirement that the leadbased paint inspection fee be included

on the HUD–1 or HUD–1A if a leadbased paint inspection is either: (1)

required by the lender, whether paid

outside of settlement (in which case

‘‘P.O.C.’’ should be used) or at

settlement; or (2) paid for at settlement.

The only change made by this rule is a

clarification to the instructions for the

HUD–1. The current instructions

indicate that Lines 1301 and 1302 of the

HUD–1 may be used for ‘‘fees for

survey, pest inspection, radon

inspection, lead-based paint inspection,

or other similar inspections.’’ The

instructions are being changed to

indicate that Lines 1301–1302 or any

other available blank line in the 1300

series may be used for these purposes.

In addition, the Department has

recently implemented several programs

to assist homebuyers in financing the

cost of lead-based paint inspections, risk

assessments, and repairs. These

programs include special requirements

for the disclosure of information

pertaining to lead-based paint on the

HUD–1 and HUD–1A, which were

explained in Notice H 96–93 (HUD)

issued by the Department’s Office of

Housing on November 5, 1996.

Most importantly, since the time the

September 13, 1996 proposed rule was

issued, the Department has replaced its

out-of-date settlement costs booklet (see

62 FR 31891, June 11, 1997). This new

booklet is also available on the RESPA

Website: http://www.hud.gov/fha/res/

respalhm.html. This revised booklet

discusses the legal provisions that allow

the buyer the option of obtaining a leadbased paint inspection, and gives an

earlier and more meaningful description

of the lead-based paint inspection

process to the consumer. The

Department is also currently engaged in

a process with the Federal Reserve

Board, referred to in Part VII(B) above of

this preamble, which involves an

overall review of settlement disclosure

forms and requirements.

IX. Rule Changes

The changes made in this final rule

are summarized below:

1. This rule amends § 3500.17(a) to

include a reference to the voluntary

disclosure format. This reference

clarifies that the Department

encourages, but does not require,

originators and servicers to provide the

format to consumers when they

anticipate a substantial increase in

disbursements from the escrow account

after the first year of the loan.

2. This rule revises the definition of

‘‘disbursement date’’ in § 3500.17(b) to

eliminate a redundant sentence that had

referred to § 3500.17(k).

3. This rule adds a definition of

‘‘penalty’’ to § 3500.17(b) to clarify that

a penalty does not include any

additional charge or fee associated with

choosing installment payments as

opposed to annual payments or for

choosing one installment plan over

another. As discussed in Part III(C)(1) of

this preamble, this new definition is

necessary to clarify, in response to

comments on the proposed rule, that a

service fee levied by the payee on

installment payments is not regarded as

a penalty.

4. This rule amends § 3500.17 (c)(1)

and (c)(2) to eliminate redundant

descriptions of the requirements of

§ 3500.17(k); the requirements of

§ 3500.17(k) are clarified by revisions to

that paragraph. This rule also makes

technical amendments to the citation of

§ 3500.17 (c)(1) and (c)(2).

5. This rule revises § 3500.17(i)(1) to

conform the language more closely to

the statutory language in section

10(c)(2)(A) of RESPA. While this

clarification pertains to escrow

accounting, it does not directly relate to

the other matters addressed in this final

rule. This is a technical clarification, not

a departure from prior requirements. As

such, the Department restates its

position that because an escrow account

statement clearly itemizes all amounts

paid out of the escrow account during

the period as required, the statement

does not also have to provide, as an

additional element of the statement, a

separate sum of all of those amounts.

6. This rule revises § 3500.17 (k)(1)

and (k)(2) to eliminate awkward and

unnecessary cross-references to the

definition of ‘‘disbursement date.’’ The

revisions to paragraph (k)(1) eliminate

language that had indicated that in

calculating the disbursement date,

servicers were to 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

language caused much public

confusion. Instead, as explained in Part

III(C)(1) of this preamble, under this

final rule servicers are required to

disburse in a timely manner, that is, on

or before the deadline to avoid a

penalty. For escrow items other than

property taxes, the rule leaves it to the

servicer to decide whether to disburse

on a date early enough to take advantage

of discounts, so long as the

disbursement basis (annual or

installments) and the disbursement date

complies with the normal lending

practice of the lender and local custom

and constitutes prudent lending

practice. For property taxes only, this

rule contains special requirements in

paragraph (k)(3).

7. This rule adds § 3500.17(k)(3) to

specify the special additional

requirements applicable to property

taxes when the taxing jurisdiction offers

the servicer a choice of disbursements

on an installment or annual basis. Those

requirements are explained in Part

III(C)(1) of this preamble.

8. This rule adds § 3500.17(k)(4) to

specify that a servicer and borrower may

mutually agree, on an individual case

basis, to a different disbursement basis

(installment or annual) or disbursement

date for property taxes, so long as their

agreement avoids a penalty, complies

with the normal lending practice of the

lender and local custom, and constitutes

prudent lending practice. This provision

is discussed in Part III(C)(1) of this

preamble.

9. This rule makes one minor

clarification to the instructions to the

HUD–1 as it relates to disclosure of

‘‘lead-based paint inspection’’ fees.

10. This rule includes as an appendix

a voluntary disclosure format that is

entitled ‘‘Consumer Disclosure for

Voluntary Escrow Account Payments.’’

This format is discussed in Part IV(C)(1)

of this preamble.

11. This rule adds a footnote

instruction to Appendix C to part 3500,

the Sample Form of Good Faith
3236 Federal Register / Vol. 63, No. 13 / Wednesday, January 21, 1998 / Rules and Regulations

Estimate, to clarify that single item

analysis with a 1-month cushion can be

used in developing the estimates for

reserves relating to lines 1000–1005 of

the Good Faith Estimate.

Findings and Certifications

Paperwork Reduction Act

The information collection

requirements in this final rule have been

approved by the Office of Management

and Budget (OMB) in accordance with

the Paperwork Reduction Act of 1995

(44 U.S.C. 3501–3520), and assigned

OMB control number 2502–0517. An

agency may not conduct or sponsor, and

a person is not required to respond to,

a collection of information unless the

collection displays a valid control

number.

Environmental Impact

In accordance with 24 CFR 50.19(c)(1)

of the Department’s regulations, this

rule does not direct, provide for

assistance or loan and mortgage

insurance for, or otherwise govern or

regulate property acquisition,

disposition, lease, rehabilitation,

alteration, demolition, or new

construction, or set out or provide for

standards for construction or

construction materials, manufactured

housing, or occupancy. Therefore, this

rule is categorically excluded from the

requirements of the National

Environmental Policy Act (42 U.S.C.

4321).

Executive Order 12866

The Office of Management and Budget

(OMB) reviewed this rule under

Executive Order 12866, Regulatory

Planning and Review, issued by the

President on September 30, 1993. OMB

determined that this rule is a

‘‘significant regulatory action,’’ as

defined in section 3(f) of the Order

(although not economically significant,

as provided in section 3(f)(1) of the

Order). Any changes made in this rule

subsequent to its submission to OMB

are identified in the docket file, which

is available for public inspection

between 7:30 a.m. and 5:30 p.m. in the

Office of the Rules Docket Clerk, Office

of General Counsel, Room 10276,

Department of Housing and Urban

Development, 451 Seventh Street, SW,

Washington, DC.

Regulatory Flexibility Act

The Secretary, in accordance with the

Regulatory Flexibility Act (5 U.S.C.

605(b)), has reviewed this rule before

publication and by approving it certifies

that this rule would not have a

significant economic impact on a

substantial number of small entities.

This rule will maintain existing

requirements, but clarify them. It also

recommends voluntary use of certain

practices that would benefit consumers,

including voluntary use of a model

disclosure format.

Executive Order 12612, Federalism

The General Counsel, as the

Designated Official under section 6(a) of

Executive Order 12612, Federalism, has

determined that the policies contained

in this rule would not have substantial

direct effects on States or their political

subdivisions, or the relationship

between the Federal Government and

the States, or on the distribution of

power and responsibilities among the

various levels of government. As a

result, the rule is not subject to review

under the Order. The rule is directed

toward clarifying existing requirements

and encouraging voluntary use of

certain practices that the Department

believes would be beneficial to

consumers.

Unfunded Mandates Reform Act

Title II of the Unfunded Mandates

Reform Act of 1995 (UMRA) (Pub. L.

104–4; approved March 22, 1995),

establishes requirements for Federal

agencies to assess the effects of their

regulatory actions on State, local, and

tribal governments, and on the private

sector. This rule does not impose any

Federal mandates on any State, local, or

tribal governments, or on the private

sector, within the meaning of the

UMRA.

List of Subjects in 24 CFR Part 3500

Consumer protection, Condominiums,

Housing, Mortgages, Mortgage servicing,

Reporting and recordkeeping

requirements.

For the reasons stated in the

preamble, part 3500 of title 24 of the

Code of Federal Regulations is amended

as set forth below.

PART 3500—REAL ESTATE

SETTLEMENT PROCEDURES ACT

1. The authority citation is revised to

read as follows:

Authority: 12 U.S.C. 2601 et seq.; 42 U.S.C.

3535(d).

2. In § 3500.17:

a. Paragraph (a) is amended by adding

a sentence at the end;

b. Paragraph (b) is amended by

revising the definition of ‘‘Disbursement

date’’, and by adding a new definition

of ‘‘Penalty’’ in alphabetical order;

c. Paragraphs (c)(2) and (c)(3) are

revised;

d. Paragraph (f) is amended by adding

a new paragraph (f)(2)(iii);

e. Paragraph (i) is amended by

revising the third sentence of the

introductory text of paragraph (i)(1) and

by revising paragraph (i)(1)(iv); and

f. Paragraph (k) is revised, to read as

follows:

§ 3500.17 Escrow accounts.

(a) * * * A HUD Public Guidance

Document entitled ‘‘Consumer

Disclosure for Voluntary Escrow

Account Payments’’ provides a model

disclosure format that originators and

servicers are encouraged, but not

required, to provide to consumers when

the originator or servicer anticipates a

substantial increase in disbursements

from the escrow account after the first

year of the loan. The disclosures in that

model format may be combined with or

included in the Initial Escrow Account

Statement required in § 3500.17(g).

(b) * * *

* * * * *

Disbursement date means the date on

which the servicer actually pays an

escrow item from the escrow account.

* * * * *

Penalty means a late charge imposed

by the payee for paying after the

disbursement is due. It does not include

any additional charge or fee imposed by

the payee associated with choosing

installment payments as opposed to

annual payments or for choosing one

installment plan over another.

* * * * *

(c) * * *

(2) Escrow analysis at creation of

escrow account. Before establishing an

escrow account, the servicer must

conduct an escrow account analysis to

determine the amount the borrower

must deposit into the escrow account

(subject to the limitations of paragraph

(c)(1)(i) of this section), and the amount

of the borrower’s periodic payments

into the escrow account (subject to the

limitations of paragraph (c)(1)(ii) of this

section). In conducting the escrow

account analysis, the servicer must

estimate the disbursement amounts

according to paragraph (c)(7) of this

section. Pursuant to paragraph (k) of this

section, the servicer must use a date on

or before the deadline to avoid a penalty

as the disbursement date for the escrow

item and comply with any other

requirements of paragraph (k) of this

section. Upon completing the initial

escrow account analysis, the servicer

must prepare and deliver an initial

escrow account statement to the

borrower, as set forth in paragraph (g) of

this section. The servicer must use the

escrow account analysis to determine

whether a surplus, shortage, or

deficiency exists and must make any
Federal Register / Vol. 63, No. 13 / Wednesday, January 21, 1998 / Rules and Regulations 3237

adjustments to the account pursuant to

paragraph (f) of this section.

(3) Subsequent escrow account

analyses. For each escrow account, the

servicer must conduct an escrow

account analysis at the completion of

the escrow account computation year to

determine the borrower’s monthly

escrow account payments for the next

computation year, subject to the

limitations of paragraph (c)(1)(ii) of this

section. In conducting the escrow

account analysis, the servicer must

estimate the disbursement amounts

according to paragraph (c)(7) of this

section. Pursuant to paragraph (k) of this

section, the servicer must use a date on

or before the deadline to avoid a penalty

as the disbursement date for the escrow

item and comply with any other

requirements of paragraph (k) of this

section. The servicer must use the

escrow account analysis to determine

whether a surplus, shortage, or

deficiency exists, and must make any

adjustments to the account pursuant to

paragraph (f) of this section. Upon

completing an escrow account analysis,

the servicer must prepare and submit an

annual escrow account statement to the

borrower, as set forth in paragraph (i) of

this section.

* * * * *

(f) * * *

(2) * * *

(iii) After an initial or annual escrow

analysis has been performed, the

servicer and the borrower may enter

into a voluntary agreement for the

forthcoming escrow accounting year for

the borrower to deposit funds into the

escrow account for that year greater than

the limits established under paragraph

(c) of this section. Such an agreement

shall cover only one escrow accounting

year, but a new voluntary agreement

may be entered into after the next

escrow analysis is performed. The

voluntary agreement may not alter how

surpluses are to be treated when the

next escrow analysis is performed at the

end of the escrow accounting year

covered by the voluntary agreement.

* * * * *

(i) * * *

(1) * * * The annual escrow account

statement must include, at a minimum,

the following (the items in paragraphs

(i)(1)(i) through (i)(1)(iv) must be clearly

itemized):

* * * * *

(iv) The total amount paid out of the

escrow account during the same period

for taxes, insurance premiums, and

other charges (as separately identified);

* * * * *

(k) Timely payments. (1) If the terms

of any federally related mortgage loan

require the borrower to make payments

to an escrow account, the servicer must

pay the disbursements in a timely

manner, that is, on or before the

deadline to avoid a penalty, as long as

the borrower’s payment is not more than

30 days overdue.

(2) The servicer must advance funds

to make disbursements in a timely

manner as long as the borrower’s

payment is not more than 30 days

overdue. Upon advancing funds to pay

a disbursement, the servicer may seek

repayment from the borrower for the

deficiency pursuant to paragraph (f) of

this section.

(3) For the payment of property taxes

from the escrow account, if a taxing

jurisdiction offers a servicer a choice

between annual and installment

disbursements, the servicer must also

comply with this paragraph (k)(3). 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.

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 in order to take

advantage of the discount for the

borrower or avoid the additional charge

or fee for installments, as long as such

method of disbursement complies with

paragraphs (k)(1) and (k)(2) of this

section. HUD encourages, but does not

require, the servicer to follow the

preference of the borrower, if such

preference is known to the servicer.

(4) Notwithstanding paragraph (k)(3)

of this section, a servicer and borrower

may mutually agree, on an individual

case basis, to a different disbursement

basis (installment or annual) or

disbursement date for property taxes

from that required under paragraph

(k)(3) of this section, so long as the

agreement meets the requirements of

paragraphs (k)(1) and (k)(2) of this

section. The borrower must voluntarily

agree; 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.

* * * * *

3. In Appendix A to part 3500, under

the text heading ‘‘Line Item

Instructions’’, and under the subheading

‘‘Section L. Settlement Charges’’, the

paragraph beginning with the phrase

‘‘Lines 1301 and 1302’’ is revised to

read as follows:

Appendix A to Part 3500—Instructions

for Completing HUD–1 and HUD–1A

Settlement Statements; Sample HUD–1

and HUD–1A Statements

* * * * *

Line Item Instructions

* * * * *

Section L. Settlement Charges

* * * * *

Lines 1301 and 1302, or any other available

blank line in the 1300 series, are used for fees

for survey, pest inspection, radon inspection,

lead-based paint inspection, or other similar

inspections.

* * * * *

4. Appendix C to part 3500 is

amended by adding a new footnote 3

after the word ‘‘Reserves’’ in the first

column of the table, and by adding the

following text under the heading

‘‘FOOTNOTES’’ at the end after the text

of footnote 2, to read as follows:

Appendix C to Part 3500—Sample

Form of Good Faith Estimate

* * * * *

Footnotes

* * * * * 3As an alternative to using aggregate

accounting with no more than a two-month

cushion, the estimate may be obtained by

using single-item accounting with no more

than a one-month cushion.

Dated: January 13, 1998.

Nicolas P. Retsinas,

Assistant Secretary for Housing-Federal

Housing Commissioner.

The following Appendix, ‘‘Public

Guidance Document, Consumer

Disclosure for Voluntary Escrow

Account Payments’’, will not be

codified in title 24 of the Code of

Federal Regulations.

Appendix

Public Guidance Document

Consumer Disclosure for Voluntary Escrow

Account Payments

The bills paid out of your escrow account

are expected to increase substantially after

the first year[.] [because llll .] Under

normal escrow practices, your monthly

escrow payment in the second year could be

much higher than in the first.

You may voluntarily choose to make

higher payments during the first year to

reduce or eliminate the monthly payment

increase in the second year. If you are

interested in doing this, contact:

lllllllllll.

[INSTRUCTIONS TO PREPARER: You are

encouraged to provide this document to

borrowers when you anticipate a substantial

increase in bills paid out of the escrow

account after the first year of the loan.

Explanation of the reason for the increase is
3238 Federal Register / Vol. 63, No. 13 / Wednesday, January 21, 1998 / Rules and Regulations

recommended. The document may be

delivered separately or combined with the

Initial Escrow Account Statement. In the

blank provided, insert the contact for further

information, including the mailing address,

fax number, e-mail address, and/or telephone

number of the contact who will provide

further information on making voluntary

overpayments during the first year. The terms

‘‘reserve’’ or ‘‘impound’’ may be substituted

for the terms ‘‘escrow account’’ or ‘‘escrow’’

to reflect local usage. These INSTRUCTIONS

TO PREPARER should not appear on the

form.]

[FR Doc. 98–1395 Filed 1–20–98; 8:45 am]

BILLING CODE 4210–27–P