Compliance Bulletin

New Escrow Rule on Higher Priced Mortgages Effective April 1
March 18, 2011

The Federal Reserve Board issued a final rule establishing the rate thresholds for applying escrow requirements to higher-priced mortgage loans (“Final Rule”). 

A higher-priced mortgage loan was first defined in 12 CFR 226.35(a)(1) of Regulation Z in 2008 as a residential mortgage loan with an annual percentage rate that exceeds the average prime offer rate for a comparable transaction by at least 1.5% for first-lien loans or 3.5% for subordinate-lien loans. Covered loans are subject to special rules including the establishment of an escrow account for payment of property taxes and mortgage insurance, restriction against payment penalties, and a requirement to determine a borrower’s ability to repay [1].

The Dodd-Frank Act amends the Truth in Lending Act by adopting the escrow requirement together with the existing 1.5% spread for first-lien Freddie Mac conforming loans. But for loans that exceed the conforming limit (“jumbo loans”), an escrow is required if the APR exceeds the applicable average prime offer rate by at least 2.5%. The existing rule does not distinguish between conforming and jumbo loans. Coverage of subordinate lien loans is not affected by the Dodd-Frank Act.

As a result, an escrow account will no longer be required for a jumbo loan with an APR that meets the 1.5% threshold but is lower than the new 2.5% threshold (hereafter referred to as “intermediate jumbo loan”). However, the Board notes that when deciding whether to require an escrow account, creditors are permitted to elect to use the 1.5% threshold even for jumbo loans.

New Official Staff Comment 35(b)(3)(v)-2 clarifies that the higher APR threshold applies only in determining if a jumbo loan is subject to the escrow requirement. Jumbo first-lien loans are subject to the other Section 226.35 protections (ability to repay and restriction on prepayment penalties) based on the existing 1.5% threshold. The Final Rule does not require termination of any existing escrow account.

Applicability of California Law. California Civil Code Section 2954 generally prohibits the imposition of an “impound” account on residential mortgage transactions, but includes a CBA-sponsored exception if “a loan is made in compliance with the requirements for higher priced mortgage loans established in Regulation Z, whether or not the loan is a higher priced mortgage loan.” [2] CBA supported this amendment so that originators and creditors could comply with the federal escrow requirement for higher-priced mortgage loans without violating California law. The “whether or not” language is intended to give the originator or creditor some latitude because of the uncertainty prior to closing whether the coverage threshold would be crossed.

An intermediate jumbo loan still comes within the revised definition of a higher-priced mortgage loan because its APR meets the 1.5 percent threshold. Therefore, if a creditor chooses to require an impound account on an intermediate jumbo loan, it should come within the Section 2954 exception as a loan made in compliance with the rules on higher-priced mortgage loans in that it is defined as a higher-priced mortgage loan and the provisions regarding prepayment penalties and determining ability to repay are complied with. Indeed, current sentiment is to favor escrows as a tool to help borrowers become aware of and to spread the true cost of ownership. If there is any doubt whether the exception applies (because an escrow is not required), the “whether or not” clause in subparagraph (F) should provide additional support for a decision to require an escrow account.

A counter-argument could be made that, while an intermediate jumbo loan is defined as a higher-priced mortgage loan, an escrow is in fact not required for this particular type of loan under federal law and regulations. Thus, requiring an escrow would violate Section 2954. This same ambiguity touches the decision not to impose an impound account for an intermediate jumbo loan. However, the statute only contemplates liability for wrongly requiring an escrow account, which could result in it being rendered void, but not for “failing” to require an escrow. What kind of liability may be fashioned from Business & Professions Code Section 17200 is a different matter.

A partial solution may be to use the statute’s allowance of a mutual agreement by the parties under Section 2954(a)(1) to establish an escrow at the option of the borrower. The language of the statute suggests that such an agreement is available where establishment of an escrow is not required.

The Final Rule is effective for covered loans for which an application is received on or after April 1, 2011.

  1. See CBA’s Regulatory Compliance Bulletins titled, Impound Accounts Allowed For “Higher Priced Mortgage Loans” dated August 17, 2009 and New Federal Rules on Higher Priced Mortgage Loans, dated July 28, 2008.
  2. California Civil Code Section 2954(a)(1)(F).

The information contained in this CBA Regulatory Compliance Bulletin is not intended to constitute, and should not be received as, legal advice. Please consult with your counsel for more detailed information applicable to your institution.

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