Servicer’s Timely Payment of Taxes

QUESTION
We are a mid-size servicer, and I am in charge of our escrow account services. A few days ago, we realized that our policy documents do not fully explain our responsibility to make tax payments.

Specifically, we do not state what constitutes the timely payment of taxes. However, we do show timely tax payments in our procedures.

So, we want to align our policy with our procedures. This review has led us to contact your Servicer Compliance Group to work with us on all our policies and procedures.

In the meantime, regarding the timely payment of taxes, can you provide some perspective and context?

ANSWER
This is an important question. In fact, there has been considerable litigation on the timeliness of tax payments. Every mortgage service must have policies and procedures fully aligned for the timely payment of taxes. I will begin my response by explicating what the term "servicer" means.

I appreciate that you have been in touch with our Servicers Compliance Group to work on the policies and procedures. Keep in mind that many regulations are interlocking, and policies and their implementing procedures should consider the cascading effect of errors multiplying due to improper integration of all applicable regulatory compliance factors.

When the terms of any federally related mortgage loan require the borrower to make payments to an escrow account, RESPA and its implementing Regulation X require[i] the servicer to make disbursements in a timely manner. The phrase “timely manner” is defined as "on or before the deadline to avoid a penalty." This requirement does not apply when the borrower’s payment is more than 30 calendar days overdue.

Regarding property taxes, if the taxing jurisdiction neither offers a discount for disbursements on a lump sum 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 otherwise agree.

Furthermore, if 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 its discretion – although it is not a RESPA requirement – make lump sum annual disbursements, as long as that method of disbursement complies with the timeliness requirements of Regulation X.[ii] RESPA encourages,[iii] but does not require, the servicer to follow the preference of the borrower if the servicer knows that preference.

Here’s an example that helps me to expand this discussion. A recent decision by the U.S. Court of Appeals for the 4th Circuit considered the meaning of the term "servicer" insofar it relates to the timely payment of taxes. The case is Harrell v Freedom Mortgage Corp.[iv] In brief, the issue, which arose as a result of a transfer of servicing, was:

(1) whether RESPA requires taxes to be paid by the entity responsible for servicing the mortgage at the time the tax payment is due, or

(2) whether RESPA demands that the entity that received funds for escrow make the tax payment when it is ultimately due.

In 2005, Harrell bought a home and financed its purchase with a loan from NYCB Mortgage Company. In 2012, Harrell refinanced with NYCB because interest rates had dropped significantly. His mortgage contract required him to make property tax payments to NYCB for deposit into an escrow account. This triggered a corresponding obligation under RESPA for NYCB to pay his property tax bills on time.

The mortgage permitted NYCB to sell the mortgage loan and transfer the servicing rights. In 2017, NYCB sold Harrell’s loan, as part of a much larger transaction, to Freedom Mortgage Corp. Freedom took over all servicing rights and responsibilities, effective October 31, 2017. Starting November 1, 2017, Harrell became obligated to pay his mortgage payments to Freedom.

Let’s now look at certain dates.

• NYCB made Harrell’s June 2017 tax payment by its due date, but the November 2017 payment was late.
• Before October 31, 2017, Harrell had deposited the funds in the escrow account overseen by NYCB.
• Ownership of the loan and the servicing rights transferred from NYCB to Freedom on October 31, 2017.
• The November 15, 2017 due date for property taxes came and went, while Harrell’s funds remained in escrow.
• In 2018, Freedom finally made the tax payment from Harrell’s escrow account, but the tax jurisdiction assessed late payment penalties and the tardy payment adversely affected Harrell’s 2017 income tax bill in the amount of $895.

Harrell filed a putative class action against Freedom, alleging that Freedom’s failure to make a timely tax payment violated RESPA, breached his mortgage contract, and was negligent. Freedom responded by disclaiming responsibility, arguing that it, Freedom, was not the "servicer" responsible for the November 15 tax payment and that NYCB was responsible. The district court agreed with Freedom and granted Freedom’s motion to dismiss.

But the 4th Circuit reversed. By requiring "the servicer" to make tax payments "as [they] become due," RESPA connects the servicer’s obligation to a payment’s due date, not the date of payment into escrow by the borrower.

Therefore, the relevant "servicer" under RESPA is the entity "responsible for servicing" the mortgage loan when the tax payment is due.

Harrell sufficiently alleged that Freedom bore the responsibility for servicing his mortgage on the tax’s due date, so under RESPA, Freedom was “the servicer” accountable for making the tax payment on time.

The court noted that its role was not to ask how NYCB and Freedom had agreed by contract to allocate servicing responsibilities between themselves. Instead, its inquiry focused on what the statute requires.

I would like to drill down further to make the foregoing outline more succinct.

First, the statute establishes the obligation for a servicer to make payments from the escrow account for taxes:

"If the terms of any federally related mortgage loan require the borrower to make payments to the servicer of the loan for deposit into an escrow account for the purpose of assuring payment of taxes, insurance premiums, and other charges with respect to the property, the servicer shall make payments from the escrow account for such taxes, insurance premiums, and other charges in a timely manner as such payments become due."

The court noted that two factors triggered the servicer’s obligation to make payments:

(1) Harrell’s loan qualified as a "federally related mortgage loan," which encompasses virtually every residential real estate transaction closing in the United States; and

(2) the terms of Harrell’s loan required Harrell to make tax payments into an escrow account.

Accordingly, Harrell’s servicer had to make tax payments from the escrow account as they became due, or Harrell could seek actual damages, statutory damages, costs, and attorneys’ fees.

Second, RESPA defines the term "servicer" to mean “the person responsible for servicing of a loan." The court combined that definition with the way RESPA[v] uses the word "servicer." That subsection connects "the servicer’s” responsibility to effect payment to the date that payment "becomes due" – in other words, the date by which payment is required. The subsection does not mention when or whether a payment is received into escrow from a borrower. This contemplates that whoever is “the servicer” when a payment becomes due must make that payment.

Third, RESPA also defines the term “servicing” as used in the phrase “the person responsible for servicing of a loan:”

"[R]eceiving any scheduled periodic payments from a borrower pursuant to the terms of any loan, including amounts for escrow accounts…, and making the payments of principal and interest and such other payments with respect to the amounts received from the borrower as may be required pursuant to the terms of the loan."

Harrell’s complaint plausibly alleged that Freedom was responsible for servicing his mortgage loan on November 15, 2017, the tax payment due date, by saying that "NYCB transferred [his] mortgage…, including the servicing of [his] loan, to Freedom" before November 15, 2017. The NYCB-to-Freedom purchase agreement confirmed that, as of November 1, 2017, Freedom acquired "all right, title and interest of [NYCB]…as Servicer under the Servicing Agreements" and "the related Servicing obligations as specified in each Servicing Agreement." Accordingly, Freedom agreed to "assume, pay, perform and discharge the obligation to service the Serviced Loans…on and after" that date.

Because Harrell’s mortgage payments became due to Freedom on November 1, 2017, that was the “effective date of transfer” of his loan under RESPA. RESPA contemplates that before this date, NYCB was the servicer. From this date forward, Freedom became the servicer.

Thus, it is appropriate for the court to conclude that RESPA places the obligation to pay taxes with the entity responsible for servicing a loan when that tax payment is due. In this case, that entity was Freedom Mortgage.

Allow me to offer a few observations.

Freedom argued that because servicing includes "making the payments of principal and interest and such other payments with respect to the amounts received from the borrower," and NYCB had received Harrell’s escrow payment, that made NYCB the servicer. But the court said this confused the statutory duties of “servicers” with the definition of "servicing." Instead, RESPA obligates “the servicer” to make timely payments from an escrow account.

The court noted that an intuitive assumption seemed to underlie Freedom’s argument, to wit, that an intermediary that receives a payment should be responsible for forwarding that payment along to the ultimate recipient. While that assumption might hold in normal transactions, it ignored the use of escrow accounts under RESPA.

Thus, here is the essential policy statement that should align with procedures:

• Borrowers do not make payments simply to a servicer; rather, they make payments to a servicer for deposit into an escrow account.
• The servicer controls the account in trust; the account is not the servicer’s account.
• Transferring servicing involves transferring control over the escrow account. 

Accordingly, there is no interpretive problem with a transferor servicer depositing a borrower’s payment into escrow and the transferee servicer being obligated to disburse those funds.

Jonathan Foxx, Ph.D., MBA

Chairman & Managing Director

Lenders Compliance Group

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[i] §§ 1024.17(k)1) and 1024.34(a)
[ii] § 1024.17(k)(1) and (k)(2)
[iii] Idem. Paragraph (k)(3)
[iv] Harrell v. Freedom Mortgage Corp., 2020 U.S. App. (4th Cir. Oct. 2, 2020)
[v] RESPA § 6(g), 12 U.S.C. § 2605(g)