In a surprising move to many, the Consumer Financial Protection Bureau (CFPB) recently put the mortgage servicing industry on notice that including certain options for repayment of a shortage in an escrow account statement may violate Regulation X. Specifically, the CFPB explained in its recent edition of the Supervisory Highlights report that one or more servicers violated Regulation X by including a lump sum repayment option — not a lump sum repayment requirement — in the escrow account statement when a borrower has a shortage that is greater than or equal to one month’s escrow payment.
Many servicers that we have spoken with over the past few weeks have questioned the CFPB’s legal interpretation of Regulation X in this context. Moreover, those same servicers have expressed concern that the CFPB’s interpretation will result in borrower confusion and potentially remove a repayment option that many borrowers have long preferred. For the reasons discussed below, we agree on both counts.
When a servicer conducts an escrow analysis and the result is a shortage that is greater than or equal to one month’s escrow account payment, section 1024.17(f)(3)(ii) of Regulation X says that “the servicer has two possible courses of action.” The servicer may either (1) do nothing and allow the shortage to exist, or (2) “require the borrower to repay the shortage in equal monthly payments over at least a 12-month period.” Separately, 1024.17(i)(1) requires that an escrow statement include “[a]n explanation of how any shortage or deficiency is to be paid by the borrower.” Notably, Regulation X provides no prohibition on the actions of borrowers, who remain free to repay a shortage at any cadence that does not exceed a servicer’s requirements.
In its Supervisory Highlights report, the CFPB explained that these “enumerated repayment options” in Regulation X “are exclusive.” Therefore, according to the CFPB, servicers that include both a lump sum repayment option and the required repayment period of 12 (or more) months were deemed by the CFPB to have violated Regulation X because the first option, lump sum repayment, is not specifically permissible under Regulation X. As a result, “the servicers violated regulatory requirements by sending disclosures that provided borrowers with repayment options that they cannot require under Regulation X.” Essentially, the CFPB equated including a repayment option to a repayment requirement and found a violation of Regulation X.
Analysis of the CFPB’s Interpretation of the Law
The CFPB’s interpretation of Regulation X and its rationale for finding violations may initially seem reasonable. After all, the law does say that “the servicer has two possible courses of action,” neither of which contemplates lump sum repayment by the borrower. However, many servicers have expressed frustration with the CFPB’s interpretation of Regulation X and believe that it is simply wrong and even potentially harmful to consumers. We’ll explain why.
It ought to be widely agreed that the framework established in Regulation X makes clear that a mortgage servicer cannot require lump sum repayment of a shortage that is greater than or equal to one month’s escrow account payment. The purpose of such requirement is obvious: Regulation X seeks to ensure servicers do not require remittance of a potentially large, unexpected payment immediately. To avert such payments, and the needless defaults that could follow, servicers must allow borrowers to repay shortages in equal installments over at least 12 months. This requirement, however, only provides limits on what a servicer can do — not on what a borrower is permitted to do. Regulation X does not place limits on how or when a borrower may choose to repay a shortage (though borrowers must comply with a servicer’s valid requirements), and we see no reason to limit a borrower’s options.
In the Supervisory Highlights, however, the CFPB appears to create such limits. By calling the “enumerated repayment options” the “exclusive” options for repayment of shortages, the CFPB seems to suggest that a borrower may not legally choose to repay a shortage in a lump sum repayment, even if the borrower prefers to do so — and servicers report that many borrowers do, in fact, prefer lump sum repayment. Alternatively, the CFPB’s guidance can be interpreted to suggest that a servicer may not be permitted to accept a lump sum escrow shortage repayment if a borrower were to initiate it. Such a position could not have been the CFPB’s intent. If a borrower prefers to pay over six months, three months, or even all at once in a lump sum, we can think of no good reason why that borrower’s choice should not be acceptable and compliant with Regulation X. If a servicer requires that the borrower pay over at least a 12-month period, the borrower should have the freedom of choosing a quicker option. Therefore, it is critical that the CFPB, the industry, and the legal system view Regulation X as imposing limits on servicers and not borrowers.
Since the issuance of the Supervisory Highlights report, the CFPB has informally indicated that borrowers should be allowed to repay escrow shortages in a lump sum and that servicers are required to accept a lump sum repayment. Thankfully, this means that the “enumerated repayment options” are not actually “exclusive.” The CFPB reiterated its position, however, that servicers cannot inform borrowers of this option on the escrow statement, though servicers may inform borrowers of the lump sum repayment option in another manner. Such a position, however, is form without substance, serves no purpose, and prevents no harm. Worse, it begets more issues, questions, and uncertainty. Are servicers now required to provide this information to borrowers if they are required to accept such payments? And if so, how can servicers safely do that without unintentionally violating another of a myriad of federal and state debt collection laws? And, are servicers even prepared to rely on informal guidance from the CFPB moving forward? If they do not rely on such informal guidance, are servicers setting themselves up for more violations by not informing borrowers of a lump sum repayment option or by accepting such payments?
In addition to uncertainty for servicers, the CFPB’s position will likely also cause borrowers harm, because they are less likely to be informed of one of their options for repayment of a shortage. In our view, escrow account statements should include all information borrowers need to make the best financial decisions for themselves, based on their own personal situation. Now, however, servicers may not inform borrowers of all options, and arguably one of their rights, in the very place such information is most helpful — the statement where borrowers are informed of the shortage and requirements for repayment. Additionally, servicers may be hesitant to create a new mailing to provide borrowers with such information, fearing additional costs and additional regulatory risk. Servicers are well aware that a large portion of mailings may go unread by borrowers inundated with mail and notices — adding another mailing will increase costs and risks while only slightly increasing the chance borrowers will obtain this pertinent information. As a result, servicers may be resigned to wait for borrowers to proactively inquire about whether a lump sum repayment is an option, and many borrowers are unlikely to do so, even if they would prefer such an option.
In arguing that servicers should be allowed to include a lump sum repayment option on its escrow account statements, we do offer a word of caution. Any such language must clearly recognize the lump sum repayment as only being an option. Servicers must avoid having escrow statements that in any way suggest the lump sum repayment is a requirement or seek to coerce a borrower to choose to pay a shortage in a lump sum.
As a reminder, servicers are only required to include “[a]n explanation of how any shortage or deficiency is to be paid by the borrower.” If a servicer were to note on the escrow statement that it is choosing to require that the borrower repay a shortage by making equal payments over a 12-month period, but also note that the borrower always has the option of paying the shortage quicker and explains how that can be done, that would seem to satisfy the actual content requirement for escrow statements. Ultimately, since Regulation X does not contain a clear prohibition on including information regarding a borrower’s right to prepay an escrow shortage, in our opinion the law ought to be interpreted such that servicers must tell the borrower how it will require repayment of any shortage, but that a servicer can also explain that borrowers do have other options that they can initiate and choose.
Finally, the CFPB has noted that its interpretation of Regulation X is consistent with one of the purposes of the Real Estate Settlement Procedures Act (RESPA), which was to result “in a reduction in the amounts home buyers are required to place in escrow accounts established to ensure the payment of real estate taxes and insurance.” However, it does not seem that the CFPB’s interpretation actually achieves this goal. Rather, a borrower will actually pay the same amount into an escrow account regardless of whether the borrower pays a shortage amount in a lump sum or if it is spread out over 12 or more months. The only difference is the time in which that amount is paid. Additionally, at least in states where interest must be paid on escrow balances, reducing the frequency in which borrowers pay escrow shortages quicker than what may be required by the servicer will actually result in borrowers potentially losing out on interest that could have been earned.
The mortgage servicing industry was rightfully taken aback by the CFPB’s interpretation of what cannot be included on an escrow statement under Regulation X. This interpretation, which was first presented in its recent Supervisory Highlights report, represents a drastic shift from what was long considered to be acceptable throughout the industry. In our opinion, the CFPB’s position is likely to cause substantial confusion amongst both the servicing industry and consumers, and will remove an escrow shortage repayment option that many consumers prefer and have long availed themselves of.
It is our hope that the CFPB will promptly take action to provide both the industry and consumers much needed relief from the damage that its interpretation has already caused and is likely to cause in the future if left unchecked. While completely changing course and adopting a different, more reasonable interpretation is preferable, providing the industry with much needed clarification and flexibility and otherwise building upon its current interpretation could also provide meaningful relief. Regardless, it seems the CFPB still ought to be able to provide assistance in a way that helps all interested parties.