www.hudclips.org U. S. Department of Housing and Urban Development Washington, D.C. 20410-8000 May 09, 1995 OFFICE OF THE ASSISTANT SECRETARY FOR HOUSING-FEDERAL HOUSING COMMISSIONER MORTGAGEE LETTER 95-20 TO: ALL APPROVED MORTGAGEES SUBJECT: Single Family Loan Production - Revision to Model Mortgage Form Single Family Loan Servicing - Escrow Account Issues Pending changes in RESPA regulations (24 CFR Part 3500, known as Regulation X) and FHA regulations will require lenders to make changes in the mortgage forms used for FHA-insured single family mortgages and to change some practices regarding maintenance of escrow accounts. The changes for both regulations were published on October 26, 1994 in the Federal Register (59 FR 53890) and corrections were published on February 15, 1995. As corrected, the changes will become effective on May 24, 1995. LOAN PRODUCTION: THE MODEL MORTGAGE FORM The Model Mortgage Form (HUD Handbook 4165.1, Endorsement for Insurance for Home Mortgage Programs [Single Family], Appendix III) is hereby amended to reflect these changes in Regulation X and FHA regulations, by substituting the following revised Paragraph 2: 2. Monthly payment of Taxes, Insurance, and Other Charges. Borrower shall include in each monthly payment, together with the principal and interest as set forth in the Note and any late charges, a sum for (a) taxes and special assessments levied or to be levied against the Property, (b) leasehold payments or ground rents on the Property, and (c) premiums for insurance required under Paragraph 4. In any year in which the Lender must pay a mortgage insurance premium to the Secretary of Housing and Urban Development ("Secretary"), or in any year in which such premium would have been required if Lender still held the Security Instrument, each monthly payment shall also include either: (i) a sum for the annual mortgage insurance premium to be paid by Lender to the Secretary, or (ii) a monthly charge instead of a mortgage insurance premium if this Security Instrument is held by the Secretary, in a reasonable amount to be determined by the Secretary. Except for the monthly charge by the Secretary, these items are called "Escrow Items" and the sums paid to Lender are called "Escrow Funds." 2 Lender may, at any time, collect and hold amounts for Escrow Items in an aggregate amount not to exceed the maximum amount that may be required for Borrower's escrow account under the Real Estate Settlement Procedures Act of 1974, 12 U.S.C. 2601 et seq. and implementing regulations, 24 CFR Part 3500, as they may be amended from time to time ("RESPA"), except that the cushion or reserve permitted by RESPA for unanticipated disbursements or disbursements before the Borrower's payments are available in the account may not be based on amounts due for the mortgage insurance premium. If the amounts held by Lender for Escrow Items exceed the amounts permitted to be held by RESPA, Lender shall deal with the excess funds as required by RESPA. If the amounts of funds held by Lender at any time are not sufficient to pay the Escrow Items when due, Lender may notify the Borrower and require Borrower to make up the shortage or deficiency as permitted by RESPA. The Escrow Funds are pledged as additional security for all sums secured by this Security Instrument. If Borrower tenders to Lender the full payment of all such sums, Borrower's account shall be credited with the balance remaining for all installment items (a), (b), and (c) and any mortgage insurance premium installment that Lender has not become obligated to pay to the Secretary, and Lender shall promptly refund any excess funds to Borrower. Immediately prior to a foreclosure sale of the Property or its acquisition by Lender, Borrower's account shall be credited with any balance remaining for all installments for items (a), (b), and (c). Revised Paragraph 2 shall be used in the mortgage forms for all loans closed on or after May 24, 1995, except for mortgage forms used for the Home Equity Conversion Mortgage (HECM) program. LOAN SERVICING: EFFECT OF CHANGES ON NEW AND EXISTING MORTGAGES A.Pre-accrual. One change in Regulation X prohibits a practice known as "pre-accrual" of escrow account items. This practice requires that funds needed for disbursement from an escrow account be deposited with the mortgage servicer at a date before the month of the disbursement date. The prohibition of pre-accrual applies to all escrow accounts established under mortgages originated on or after May 24, 1995. Mortgage forms for loans made before May 24, 1995 provide for pre-accrual. Lenders may continue with pre-accrual for those loans as long as it does not result in an escrow account balance higher than the balance permitted by Regulation X. Lenders may never require payments that result in an escrow balance exceeding the balance (including a two-month cushion) permitted by Regulation X. A related change in FHA regulations, also effective May 24, 1995, removes the current pre-accrual requirement for FHA-insured mortgages. Effective May 24, 1995, this requirement will no longer apply to any FHA-insured single family mortgages, including existing ones. 3 B.Cushion. From 1990, FHA has required mortgage forms to explicitly provide for two month cushion (except on the MIP due to FHA). FHA regulations have allowed the two months' cushion since 1976. FHA has not pre-empted any state law pertaining to whether mortgage forms need to provide for a cushion. The revised mortgage Paragraph 2 that is set forth above will replace the specific reference to a cushion with a general reference to limitations on escrow account amounts (including cushions) in Regulation X. The revised Paragraph 2 is intended to permit any cushion permitted by Regulation X, except that no cushion is permitted for the mortgage insurance premium. C.Aggregate versus Separate Item Accounting. Regulation X distinguishes between "aggregate" and "separate-item" accounting methods. While FHA model mortgages have allowed separate item accounting, lenders must comply with Regulation X's requirement to use the aggregate method. This is effective after the phase in period ending October 27, 1997, for mortgages originated before May 24, 1995, but applies immediately to any mortgage executed on or after May 24, 1995. D.Surpluses, shortages and deficiencies. The revised Paragraph 2 that is set forth above does not contain specific guidance on escrow account surpluses, shortages or deficiencies but refers to practices required or permitted by Regulation X. Regulation X includes requirements regarding the handling of these matters. Current requirements on this subject are being deleted from the FHA regulations, effective May 24, 1995. Lenders shall comply with Regulation X regarding escrow account surpluses, shortages and deficiencies for all mortgages. Regulation X sets a ceiling on the amount that can be held in an escrow account, but mortgage contract terms that would permit only a smaller amount will continue to govern the lender's obligation to the borrower. In some instances, existing FHA-insured mortgages contain provisions on these matters that restrict the lender more than Regulation X. For example, Regulation X would permit escrow surpluses less than $50 to be credited against the next year's escrow payments. Some existing FHA-insured mortgages permit this only at the option of borrower, while also giving the borrower the option of requiring a refund payment to the borrower. For such mortgages, the lender could not apply the surplus to next year's payments without approval of the borrower. Regulation X requires refunds of larger surpluses. Because the lender must comply with the restrictions of Regulation X, it could not rely on language in some existing FHA-insured mortgages that might permit the lender to choose to apply these larger surpluses to the next year's escrow payments in lieu of a refund. Mortgage language that may require immediate payment in full of a shortage or deficiency also cannot be enforced because Regulation X specifies the time frames that a lender must provide for a borrower to cure shortages or deficiencies of different sizes. 4 E.Other items in Regulation X. Lenders should not rely on this Mortgagee Letter for a full description of the escrow account provisions of Regulation X. If you have any questions, please contact your local HUD office. Sincerely yours, Nicolas P. Retsinas Assistant Secretary for Housing- Federal Housing Commissioner