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Thursday, November 20, 2014

Mortgage Insurance Escrow Cushion at Closing

QUESTION
Our Company offers loans requiring mortgage insurance (MI) but collect the MI premiums with the monthly mortgage payment, with no upfront MI premiums collected at closing. 

May we collect a cushion to avoid an escrow shortage at the end of the year?

ANSWER
Bottom Line Up Front: You would not collect a “cushion” at closing but you may collect an “escrow deposit” to ensure that the consumer’s mortgage insurance premiums are paid in a timely manner, ahead of due dates as applicable, to avoid penalty or harm to the consumer, and to avoid a potential escrow shortage.

A “cushion” or “reserve” should not be confused with the “escrow deposit” collected at closing. Even though these terms are often used and understood interchangeably, Regulation X, the implementing regulation of the Real Estate Settlement Procedures Act (“RESPA”), provides that that in addition to the escrow deposit, the servicer may charge the borrower a cushion that shall be no greater than one-sixth of the estimated total annual payments from the escrow account (i.e., two monthly payments cushion as a maximum allowable reserve). Regulation X defines cushion or reserve as “funds that a servicer may require a borrower to pay into an escrow account to cover unanticipated disbursements or disbursements made before the borrower's payments are available in the account”. 

If the escrow deposit is accurately calculated and collected at closing, the borrower’s payments will be available in his or her escrow account to cover the premiums when due.  Mortgage premiums disbursed on a consistent monthly schedule (as described in the question) cannot be considered “unanticipated” and, therefore, would never be a need to collect a “cushion” to cover unknown disbursements as allowed with other categories of escrow payments under Regulation X. 

The prepaid escrow MI deposit would be included on the HUD as with other prepaid escrow items. For example, the mortgage insurance escrow deposit required would be entered on Line 1003 of the HUD to reflect the corresponding amount disclosed on line 9 of the GFE.

The escrow deposit amount should be the least amount possible to ensure that payments can be made when due, and at the same time achieving a target balance of zero dollars remaining at the end of projected escrow year. Of note, the escrow year is defined under Regulation X as twelve consecutive months, not necessarily twelve calendar months. If the escrow deposit is accurate at closing, there should be no need to collect a “cushion” for monthly mortgage insurance premiums.

When MI is collected upfront at closing, the premium is typically added to the total cash settlement and financed into the mortgage. In your scenario, the insurance premium is not a settlement cost to be paid at closing. HUD Line 902 would indicate “zero” as would the disclosed amount of line 3 of the GFE. The consumer should understand the difference between MI escrow deposits and upfront MI premiums.  

Final Note Except for the advance escrow deposit allowable at closing, no pre-accrual deposits can be collected during the servicing life of the loan. Servicers may resolve escrow shortages under annual escrow analysis adjustments. When complying with Regulation X’s escrow requirements, remember that each of the follow require distinct compliance procedures:

·        Initial Escrow Account Analysis [12 CFR 1024.17(c)(2) and (3) and 12 CFR 1024.17(k)]
·        Annual Escrow Account Statement requirements [12 CFR 1024.17(i)]
·        Shortages, Surpluses, and Deficiency requirements [12 CFR 1024.17(f)]

Wendy Bernard
Director/Legal & Regulatory Compliance
Lenders Compliance Group