Closer To Pittsburgh

An excellent issue was raised on Twitter today that I wanted to write about in some detail.  So here’s the setup:

-Out of the blue, the mortgage servicer sends our homeowner a check for $700+ which turns out to be a refund from the escrow account.  Homeowner is struck with joy at this unexpected windfall.  Presumably (although I’m taking artistic license at this point), homeowner has grand designs on taking said windfall and putting it to well-deserved use.

And here’s where Darkcloud Closer (aka me) steps in and says, “Let’s slow down just for a bit.”  Because the truth is…, well, let’s cover some more foundation before we get to “The Truth”.  An escrow account is essentially a fancy word for an account which holds someone else’s money for a particular purpose.  Attorneys have them to hold funds on behalf of clients.  Real estate settlement companies use them to hold funds pending distribution from a closing.  And a mortgage servicer uses them to hold the monthly payments for homeowner’s insurance and property taxes until the annual bills come due.  Because these are accounts controlled by one party (the mortgage servicer) of funds that are really for the benefit of another party (the homeowner), there are some serious regulations that covers how a servicer can administer the account.  One of the requirements is under RESPA (short for Real Estate Settlement and Procedure Act) which prohibits a lender from holding an excess reserve in an escrow account.  At one point, servicers could hold an unlimited reserve in the event that an insurance premium or property tax jumped a significant amount unexpectedly.  That way, the servicer was never having to try to collect extra funds from the homeowner in a short period of time or come up with their own money to pay the insurance premium or tax bill.  But now (and for quite a few years actually), RESPA only allows a two month reserve to be held by a servicer.  So, for example, Joe owns a home with annual property taxes of $1000 and an insurance premium of $200.  So add those up, divide by 12 and, voila’, Joe’s escrow payment is a nice, flat $100 per month.  Next step is to figure out when the escrow account is going to hit its minimum ending balance.  In Western Pennsylvania, that is typically late summer when school taxes are due (except in the City of Pittsburgh which operates on a different calendar for school taxes).  So let’s say Joe’s school taxes are due in August, then his escrow balance should hit it’s lowest point at the end of August.  For a two month reserve, Joe’s servicer can keep a reserve up to $200 (twice his monthly payment) and that’s the amount he should have right before Labor Day.

Now, what happens if it’s not at the right reserve?  If there isn’t enough money in escrow, then the servicer will adjust the escrow payment to add additional funds to the escrow.  In short, monthly payment increases.  The good part for the homeowner is, even if there isn’t enough money in the escrow to pay a bill, the servicer will pay it even if the servicer has to kick in money to pay it in full.  That means the payment is going to adjust even higher when a fix is made down the line though.

If there is too much money in the escrow, then the opposite happens: the payment decreases.  But the lender will also refund the amount that exceeds what the lender is allowed to keep as a reserve.  And this is what happened to our lucky homeowner.  At least we hope.

But before we buy that sparkly trinket we’ve wanted, first our homeowner should be checking out why exactly an escrow refund happened.  And for this, we have to dig beyond the trigger of simply “balance exceeded permitted reserve”.  To get a $700+ escrow refund, something fairly significant happened to cause the balance to exceed the permitted reserve.  So let’s move on to “The Truth” or actually more like a few possibilities of it:

1.  The Homestead Exemption:  This was floated on Twitter as the possible culprit.  If it were possible, it would be supremely good news for our homeowner as it would mean that the taxes were significantly lowered by the exemption.  Here’s the rub though:  the exemption only reduces the value of a property by $15,000 for county taxes.  Based on a millage rate of 4.69 in Allegheny County, that’s only a dollar reduction of about $70.  Now it also qualifies the homeowner to save on school taxes, but the amount varies based on the school district.  So there are some additional savings available for school taxes, but the odds of saving over $600 per year in school taxes though is virtually nil.  And if the previous owner had the homestead exemption also, any excess funds being held in escrow was unlikely to be caused by a new homestead exemption filing.

2.  Other reduction in taxes:  Possible because an assessment appeal could have been filed to reduce the assessed value of the property.  Or the municipality or school district could have reduced their millage rates.  But incredibly long odds of those happening.  In the former, the homeowner would have known all about it and the latter just doesn’t happen, especially now when D.C. and Harrisburg are cutting  back dramatically.

3.  Taxes were overestimated at closing:  One of the great misunderstandings that most people have about taxes is that they’re so easy to get.  For Allegheny County, it’s true.  Online, look ‘em right up on the internet.  Now, what about the others? Where do you look them up? You don’t.  You order them from the tax collector.  You mail a check (yes, via the mesozoic era USPS) or you take a check in yourself and ask for a statement.  In any event, the settlement company typically is charged with obtaining this information but they can make errors.  If an error was made in documenting the amount of the taxes to the lender at closing, it’s possible that the lender simply was holding too much money.  This is the best possible outcome for our homeowner as it means that the only screwup was that they were being overcharged previously, but now the error has been fixed.

4.  Taxes were paid in duplicate at closing:  Because of the cumbersome nature of documenting tax amounts, settlement companies don’t want to order a tax statement the day before closing.  So it does happen that sometimes a seller would pay a tax right before it’s due, but it happens after the tax statement for the settlement company is prepared.  So the seller pays the tax from their escrow account and the buyer has money set aside to pay it shortly after the closing.  But the buyer never gets billed for it because the seller has already paid it.  There are two problems with this scenario.  The first is that, if it did happen this way, the buyer has really been refunded money thanks to a duplicate charge to the seller.  If discovered by the seller, the seller could attempt to recover the refund that the buyer received.  The second is that almost every lender would never escrow any tax bill coming due in less than 60 days.  So although this could happen, it’s rare.

5.  A tax wasn’t paid from the escrow:  Sadly, this is the most likely of the possibilities.  In light of the large amount of the refund, something went majorly awry and not paying one of the taxes in its entirety is the quickest way to end up with a $700 excess in reserve.  How does a bill just not get paid?  Two main causes:

i. The settlement company didn’t put the correct information for the tax billing on the deed meaning the tax bills are going somewhere else.  The deed in Pennsylvania is required to have a Certificate of Residence that instructs the assessment office where to send tax bills and other assessment notices.  In Allegheny County, a deed must have an address for general assessment notices and a separate address for tax billing.  If the tax billing address isn’t completed correctly, the bills aren’t going to go where the escrow money is being held.  And if the servicer doesn’t get a bill, it isn’t going to track it down.

ii. The assessment office didn’t get the new tax billing address changed in time and when the tax bill was mailed by the tax collector, the tax collector still had the previous owner listed.  Again, no tax bill, no pay

So if the tax bill wasn’t paid, the servicer is responsible, right?  Uh, no.  A mortgage generally has a section that identifies the borrower on the loan as the party responsible for paying any debt which is assessed against the property.  If it is paid through the escrow account, the servicer is just helping out (more or less, there are some caveats, quid pro quos, etc. at play as well). But what could very well happen is that when the tax billing is corrected and the escrow account is now paying the proper amount, an escrow deficiency will result which could dramatically increase the monthly payment.  Simply sending the $700 back to replenish the escrow may be the best move in such a situation.

Well, grrr.  Most of these don’t sound very appetizing!  Nope.  As anyone should expect, receiving a check out of thin air for that sum of money should be treated with a healthy dose of skepticism.  Someone screwed up, end of story.  Hopefully, the screwup is only in the past.  But to verify, the homeowner must contact the tax collectors to see if any payments have been missed.  They should also go back to their settlement company and ask questions about whether or not the correct information was provided to the servicer.  They should also check with the assessment office to make sure that all of the information for ownership and tax billing is correct.  If it all checks out, everything is paid and the escrow is finely tuned, then and only then should our homeowner friend take that check and do whatever their little heart desires.

Sorry for the raincloudish post here, but better to deal with the raindrops before you go and spend that refund on something other than an umbrella.