Mortgage escrow interest rules face challenge from 10 states

Mortgage escrow interest rules issued by the Office of the Comptroller of the Currency, or OCC, are facing a court challenge from 10 state attorneys general. The dispute matters for homeowners whose mortgage payments include money set aside for taxes and insurance: at some federally regulated institutions, the rules let the bank decide whether that balance earns interest.

According to CNBC, the states sued the OCC and Comptroller Jonathan Gould in U.S. District Court in Oregon, asking the court to invalidate two rules issued in May that took effect June 18. The states allege that the agency exceeded its authority.

The rules apply to national banks and federal savings associations supervised by the OCC. They do not cover every mortgage lender or servicer. One rule confirms those institutions can set escrow-account terms, including whether to pay interest or charge fees. The other says federal law overrides conflicting state requirements on those terms, CNBC reported.

How do mortgage escrow interest rules affect homeowners?

An escrow account is a separate account managed with a mortgage payment. A borrower typically sends a monthly amount for property taxes and homeowners insurance, plus mortgage insurance when it is required. The lender or servicer then pays those larger bills, which are generally due once or twice a year.

That timing can leave a meaningful balance in the account for part of the year. Lereta, a provider of real-estate-tax and flood data to mortgage servicers, estimates that about 80% of mortgage holders have escrow accounts, CNBC reported. Homeowners without one generally pay their tax and insurance bills directly.

The immediate effect will depend on three facts: whether a homeowner has an escrow account, whether their state or territory requires interest on escrow balances, and whether the relevant institution is a national bank or federal savings association covered by the OCC rules. The rules permit covered institutions to decide on interest; they do not establish that every affected lender has stopped paying it. The lawsuit could also change the result.

CNBC reported that 14 states and U.S. territories have escrow-interest requirements, although the details differ. The states’ complaint says Rhode Island requires escrow balances to earn the rate paid on a regular savings account. Maryland requires an annual rate tied to the yield on one-year U.S. Treasuries, according to the complaint.

What could the lost interest be worth?

The amount varies with the balance, the applicable state rule and how that rule calculates interest. CNBC offered an illustration: $5,000 earning 0.63% for a year would generate $31.50, while the same balance at 4% would generate $200. Those figures are examples, not rates that apply to every escrow account.

Depending on the lender and state, interest may be added to the escrow balance or paid to the homeowner. CNBC also reported that some homeowners may receive a 1099-INT tax form for escrow interest. For now, the central legal question is whether the OCC can displace state escrow-interest requirements for the institutions it regulates.

This story draws on original reporting from CNBC.