Flood Insurance Escrow When Property Is No Longer in a Flood Zone

Issue/Inquiry

The Bank has a loan for which it escrows for flood insurance. However, it recently received a life-of-loan determination that the property was no longer in a Special Flood Hazard Area. Should the Bank obtain verification to determine whether a mistake was made? In addition, if flood insurance is no longer required, should the Bank give the borrower an option to continue the escrow or refund the escrow balance to the borrower?

Response Summary

If the escrow account has been established for other purposes, such as the payment of real estate taxes or hazard insurance, the Bank should determine whether the borrower wishes to continue the flood insurance coverage. If not, the Bank should perform a short-year analysis and calculate the amount of any adjustments or surplus. If there is a surplus, which is the amount by which the current escrow account balance exceeds the target balance for the account, such funds could either be refunded to the borrower or applied to the account, depending on the amount.

If the escrow account was established solely for the payment of flood insurance premiums, then the Bank should determine whether the borrower wishes to maintain flood insurance coverage. If not, the Bank should cancel the escrow account and apply any surplus in an appropriate manner. In addition, if the escrow account was established under the higher priced mortgage loan (“HPML”) requirements of Regulation Z, then the Bank must provide a notice of cancellation to the borrower three business days prior to terminating the escrow account.

Response Detail

With a life-of-loan flood determination, the flood search company will notify a financial institution of any changes in the flood map on which the original determination was based. Since the institution is not making, increasing, renewing, or extending a loan, it does not have to obtain a new determination or provide a Notice of Special Flood Hazard for the existing loan. 12 CFR 339.3(a),9(a),(d). However, it would be prudent to verify that a change has been made and the nature of such.

Whether the financial institution needs to do anything else depends upon the nature of the change. If the change is to the date of the flood map, but no substantial change has been made to the map, then nothing more needs to be done. If the change places a property in a Special Flood Hazard Area, then the institution must initiate its forced placement procedures, since it has now determined during the term of the loan that the property is not insured against flood hazard in a sufficient amount. 12 CFR 339.7(a).

If the change removes the property from a Special Flood Hazard Area and flood insurance coverage is no longer required, then the Bank should notify the borrower of this fact so the borrower can terminate the coverage. In this case, the Bank has been escrowing the flood insurance premium. As such, it should follow the Real Estate Settlement Procedures Act (“RESPA”, as implemented by Regulation X) requirements for adjusting or terminating an escrow account.

With respect to escrow accounts, a financial institution is required by RESPA to perform an escrow account analysis at least once for each 12-month period, known as an “escrow account computation year”. Such analysis is an account procedure to perform the following:

• Determine the appropriate target balances.
• Compute the borrower’s monthly payments for the next escrow account computation year.
• Compute any deposits needed to establish or maintain the account.
• Determine whether shortages, surpluses, or deficiencies exist. 12 CFR 1024.17(b).

After conducting the escrow account analysis, the financial institution must provide the borrower with an annual statement that itemizes the following factors:

• The amount of the borrower’s current monthly payment
• The portion of the monthly payment being placed in the escrow account
• The total amount paid out of the escrow account during the period for taxes, insurance premiums, and other charges, as separately identified
• The balance in the escrow account after the period
• An explanation of how any surplus is being handled
• An explanation of how any shortage or deficiency is to be paid by the borrower
• The reasons why the estimated low monthly balance was not reached, if applicable. 12 CFR 1024.17(i)

The annual statement must be submitted to the borrower within 30 days of the completion of the computation year.  The term “submitted” means the delivery of the statement, and the “delivery” is placing the statement in the United States mail, first-class, postage paid, and addressed to the last known address of the recipient. Hand delivery also constitutes as a delivery. 12 CFR 1024.17(b),(i).

After the escrow account analysis is performed, the Bank and the borrower can enter into a voluntary agreement for the forthcoming escrow accounting year, which will allow the borrower to deposit funds into the escrow account in amounts greater than the established limits. Such an agreement shall cover only one escrow account computation year, but a new voluntary agreement may be entered after the next escrow account analysis is performed. The voluntary agreement may not alter how surpluses are to be treated when the next escrow account analysis is performed at the end of the escrow account computation year covered by the voluntary agreement. 12 CFR 1024.17(f)(2)(iii).

If the financial institution wants to adjust payments sooner, RESPA allows the institution to issue a “short-year statement” in order to end the escrow account computation year and establish the beginning date of the new computation year. An escrow account analysis should be performed just as for the annual statement, but it would reflect a trial balance of the account during the short-year rather than the 12-month period for the annual statement.

The short-year statement should be submitted to the borrower within 60 days of the end of the short-year. 12 CFR 1024.17(i)(4). The term “submitted” has the same meaning as it does for the annual statement, as defined above.

RESPA does not restrict or require the use of the short-year statement, but rather only describes its effect in establishing the beginning date of the new computation year. Although financial institutions often use short-year statements to bring the escrow account computation year into line with its business cycle, such statements could also be used as a way of reflecting changes in payments, rather than waiting for the end of the escrow account computation year, in order to determine the appropriate trial balances as well as resolve deficiencies and surpluses.

For both the annual statement and short-year statement, if the escrow account analysis reveals a surplus of $50 or more, the servicer shall refund the surplus within 30 days of the analysis. If the surplus is less than $50, the servicer may refund such amount to the borrower, or credit such amount against the following year’s escrow payments, in accordance with the mortgage documents. 12 CFR 1024.17(f)(2).

The foregoing discussion assumes that there is a continuing escrow account for other purposes, such as escrowing for real estate taxes or hazard insurance. However, if the escrow account was established solely for the payment of flood insurance premiums, the Bank should determine whether the borrower wishes to maintain the flood insurance coverage. If the escrow account was established for the payment of other charges in addition to flood insurance premiums, then the Bank should cancel it after performing a short-year analysis and determine whether there is a surplus. If there is a surplus, the Bank should refund the surplus or apply it to the borrower’s account, as discussed above.

In this case, since the escrow of the cost of flood insurance is no longer required, the Bank should conduct a short-year analysis as well as determine whether the borrower wishes to maintain flood insurance. If the borrower does not, and the analysis reveals a surplus, then the Bank would refund or apply such to the borrower’s account, depending on the amount.

If the escrow account was established for an HPML under Regulation Z, a 30-day notice is typically required to cancel it. However, this would not be required in this case, since closing the escrow account is due to a borrower-requested change. While the Bank may inform the borrower that the borrower is no longer required to escrow for flood insurance, the borrower is the one who ultimately makes the decision as to whether to keep or close the escrow account. Since the borrower will be requesting the cancellation, the escrow cancellation notice should be provided so that it is received at least three business days prior to the closure of the escrow account. 12 CFR 1026.35(b).

This response is for informational purposes only and is not intended for legal guidance.

This entry was posted on Monday, January 6th, 2020 at 6:00 am.