Payment Shock Notices

QUESTION

During a banking examination, the examiner said we should consider issuing a payment shock notice. We do not believe there is a requirement to issue such a notice. Although it was only a suggestion, we are a concerned that our regulator will frown on our not providing this notice. What is a payment shock notice? And, is a payment shock notice a regulatory requirement?

ANSWER

A payment shock notice is a voluntary notice that a lender or servicer may provide to a borrower to alert the borrower to the potential for a substantial increase in property taxes for a home. A typical example involves a newly constructed home, where the property taxes for the first year may be based on the unimproved value or only partially on the improved value. This situation can result in a substantial increase in the property taxes once the taxes are fully based on the improved value.

Consider this notice a Best Practice!

HUD actually took a position on this subject twenty years ago. In deciding to adopt a Best Practice approach to allow a payment shock notice – but not mandate the notice – HUD stated:

“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 the 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." [63 FR 3214, 3233, 3237-3238 (1998)]

So, this is in line with a Best Practice procedure, which is good for the lender, servicer, and consumer in the long run. I believe that it is appropriate to provide a payment shock notice when a lender or servicer anticipates a substantial increase in the bills paid out of the escrow or impound account after the first year. By the way, the payment shock notice can be delivered with or separate from an initial escrow account statement. [63 FR 3214, 3237-3238 (1998)]

Think of this notice as a Best Practice that is common and customary, which I would guess is why the examiner recommended it to you. By issuing the payment shock notice, you are advising the borrower of the potential for a substantial increase in bills paid out of the escrow or impound account because of property taxes (or another applicable item) after the first year. This procedure then gives the borrower a chance to voluntarily make higher payments into the account during the first year to offset the payment shock.

Jonathan Foxx

Managing Director

Lenders Compliance Group