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U. S. DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT
WASHINGTON, D. C. 20410

January 30, 1984
OFFICE OF THE ASSISTANT SECRETARY FOR
HOUSING-FEDERAL HOUSING COMMISSIONER
Mortgagee Letter 84-1
TO:  ALL APPROVED MORTGAGEES
SUBJECT:  Capitalization Accounting
 
     The Department has, for years, dealt with the "capitalization
accounting" (C.A.) issue in the single family programs on a per case
basis without setting forth a distinct policy.  HUD's position has
always been influenced by the fact that in the great majority of
cases where mortgage payments are maintained current during the
mortgage term, the use of capitalization accounting by the lender
results in a substantial interest benefit to the borrower.
 
     Capitalization accounting is defined in the Standard
Accounting Manual for Savings and Loan Associations as ". . .
applying the monthly advance payment for taxes and insurance to the
unpaid principal balance of the loan."  This gives the mortgagor the
benefit of a reduction in principal with a corresponding reduction in
interest.  When tax and insurance payments are made by the mortgagee,
the principal balance increases by the amount of the payments made.
 
     A capitalization accounting system may make it more difficult to
 determine the status of the escrow accounts unless separate record
 accounts of the escrows are maintained. Capitalization accounting by
 supervised mortgagees is not a violation of HUD regulations relating
 to escrow (24 CFR 203.550) so long as the lender observes our
 accounting and depository requirements, the periodic escrow analysis
 requirement, and the timely payment of escrow item billings.  HUD
 acknowledges the existence of the C.A. method in HUD Handbook 4110.2 
 (Fiscal Handbook) which requires the mortgagee using C.A. to
 recompute its capitalized account when making a claim for insurance
 benefits.
 
     It is, therefore, prohibited for a HUD-approved mortgagee
 employing the C.A. method to capitalize delinquent mortgage payments
 (including principal, interest, taxes and insurance) or late
 
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 charges. Supervised mortgagees (as defined in 24 CFR 203.3) may
 capitalize funds actually advanced to pay taxes, insurance or other
 escrow items.  Nonsupervised mortgagees, as defined in 24 CFR 203.4,
 may not employ the C.A. method in servicing single family mortgages;
 to do so would violate 24 CFR 203.4(b)(3) which prescribes the
 segregation and handling of escrow funds.
 
     Mortgagees employing the C.A. method must avoid the practices
prohibited in this Mortgagee Letter and shall audit and correct any
mortgage account where violations may have occurred.
 
    HUD takes the position that 24 CFR 203.20 relating to the
maximum interest rate and interest payable is to be construed to
preclude the possibility of charging interest upon interest in the
capitalization process.
 
    For further information contact Richard B. Buchheit, Director,
Single Family Servicing Division on (202) 755-6672.
 
                               Sincerely,
 
                               Maurice L. Barksdale
                               Assistant Secretary
 
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