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The Truth about Escrow Cushions

The Real Estate Settlement Procedures Act (RESPA) addresses escrow accounts and the amounts that a lender may hold for payment of the borrower’s real estate taxes, homeowner’s insurance, and other items. A lender may retain a cushion, but the amount of the cushion a lender can maintain is limited by Section 10 of RESPA. Following are some common questions people have about escrow accounts and some answers.

Does RESPA require an escrow account to be maintained?

No, RESPA does not require that borrowers maintain an escrow account. A lender, however, can require the borrower to escrow for taxes, insurance, etc. as a condition of providing the loan. The borrower may also be permitted to elect to establish a deposit account of funds (pledging an amount upfront for these items) or elect to pay them directly.

If an escrow account is maintained with the lender, does RESPA require the lender to hold an amount as a cushion?

Although lenders will likely require some level of cushion to make sure the escrow is sufficient to pay the taxes and insurance amounts when they become due, RESPA does not the lender to maintain a cushion. RESPA only sets a limit on the maximum amount a lender may require a borrower to maintain a balance in the account.

How do I estimate the amount my lender may require for my escrow account?

Determine the projected tax bill and homeowner’s insurance bill and when they will become due. Then create a monthly schedule for the next twelve months showing the amount to be paid into your escrow account each month, the amount to be paid out for each escrow item per month, and the running balance. At the point where the balance is the lowest, calculate how much it would take to bring the balance to zero and increase all monthly balances by that amount. Lastly, add up the total amount of all distributions to be made from the account for the twelve month period and calculate 1/6 of that amount. This amount (1/6 of the total distribution) is the likely cushion required by the lender. Add that amount (the cushion) into the beginning balance required for the twelve-month schedule. The lender will require the cushion up front if the escrow account is new. If it is an existing account under annual review, the lender will compare the prior year to the estimate for the upcoming year and, if the cost of escrow items will increase, the lender will require the difference to be paid to increase the balance accordingly.

What is the maximum amount the lender may require as a cushion?

Section 10 of RESPA establishes the maximum cushion allowed at 1/6 of the total amount of the escrow items to be paid annually. Although a lender is permitted to require less, the trend among most lenders is now to require the maximum amount allowed under RESPA.

What can I do if I believe the lender is requiring an excessive cushion or escrow amount?

A borrower is permitted to request confirmation of the amounts requested from the lender. Under Section 6 of RESPA, a qualified written request may be submitted to the lender to obtain financial verification of the account’s servicing. The lender must confirm the request was received within 20 business days and then provide a response within 60 business days. If the matter is not corrected or the amounts required are not explained to the borrower’s satisfaction, a consumer complaint may be lodged with the Department of Housing and Urban Development. In doing so, be sure to provide all documentation substantiating the amounts to be paid from the account as well as the cushion calculation you believe is correct.


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