By Jim McGurer, SVP Operations
By law, servicers are required to conduct escrow analyses (EAs) on most first mortgage accounts every year. However, the timing of when these analyses are done and when the statements are sent to borrowers is left up to the servicer.
While lenders can choose any schedule, there are some best practices to keep in mind to minimize homeowner confusion and be less disruptive for servicers, in terms of inbound calls and the need for advances.
Approaches to Escrow Analysis Scheduling
In general, servicers tend to take one of two paths when scheduling EAs:
- Statement date approach – Conducting the EA based on the borrower’s statement date.
- Tax cycle approach – Conducting the EA after a full year’s tax payment has been made.
Across the industry, probably 20% of servicers use the statement date cycle vs. 80% that wait until the prior tax year is completed.
Why the Tax Cycle Approach is Preferable
In our experience, there are significant advantages to the latter approach. Why?
When you do an analysis based on the statement date, it can fall between tax cycles. This can result in surprises for the borrower based on estimated tax and insurance bills that have yet to arrive.
These issues can be magnified in certain tax jurisdictions, like Cook County, Illinois. That county, for example, has a two-payment tax cycle in which the first payment is a provisional tax payment equal to 55% of the prior year’s annual tax, and the second payment is often larger to reflect the total payment for the year.
So, if a servicer runs an analysis based on the first installment, they run the risk of severely underestimating the next year’s full tax bill and creating an enormous shortage in the customer’s account. By using the tax cycle method, the EA would be based on the full year’s payment.
Case Study: The Cost of Poor Scheduling
A few years ago, we did an analysis for a large servicer that was using the statement-date approach that showed the economic consequences of this non-optimal schedule.
In an effort to normalize the workload throughout the year, the servicer was running their EAs monthly, based on their state counts. But they hadn’t taken into account the timing of the tax installments. As a result, the servicer was advancing millions of dollars every year to cover escrow shortfalls.
Our findings suggested that they could significantly reduce these advances by simply moving to a tax cycle schedule.
Considerations When Transitioning to a Tax Cycle Schedule
Having highlighted the benefits of tax cycle scheduling there is a caveat that servicers need to be aware of if they are planning to make the switch from statement date to tax cycle.
The first year that you change the schedule, there will be one-time shortages for many of your borrowers, since their EAs will be moving backward. So instead of doing the EA in March, it will be done in February, and there will be one month’s less money in the account. Over time, this will most likely create less confusion, but in year one, it is something to consider.
The Growing Importance of Escrow Analyses
Historically, EAs have pretty much always been under the radar. But as my colleagues have pointed out in a recent series of blogs (read part 1 and part 2 here), this is about to change thanks to coming increases in real estate taxes as well as both homeowners and flood insurance.
And there are signs that borrowers will be paying greater attention to their EAs. Recently, the Washington Post ran an article with a bold headline: “Why your mortgage payment went up—and what you can do about it.”
The Case for Off-Cycle Escrow Analyses
Given the heightened awareness and concern about rising monthly payments for tax as well as for insurance, servicers, depending on their portfolios, might want to consider running off-cycle EAs. Traditionally they haven’t done this on a widespread basis due to the cost. But if it can help customers get in front of a shortage faster, lessening the shock and reducing escrow advances, we may see this.
Most servicing systems allow a servicer to run a trial ahead of time to see what that shortage would look like. If a servicer sees an area of the country or a particular month of the year where there is a sharp upward spike in escrow advances, that might signal that trial EAs would be prudent.
Reduce Confusion and Costs Through Smart Scheduling
A well-planned escrow analysis schedule can minimize borrower confusion, reduce escrow shortfalls, and improve servicer efficiency. Servicers should assess their portfolio needs and consider adopting a tax-cycle-based approach or incorporating strategic off-cycle EAs when necessary.
For more information, contact us at sales@LERETA.com.
