[Federal Register Volume 61, Number 171 (Tuesday, September 3, 1996)]
[Proposed Rules]
[Pages 46511-46527]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-22371]



  Federal Register / Vol. 61, No. 171 / Tuesday, September 3, 1996 / 
Proposed Rules  

[[Page 46511]]



DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT

24 CFR Part 3500

[Docket No. FR-4079-P-01]
RIN 2502-AG75


Office of the Assistant Secretary for Housing-Federal Housing 
Commissioner Real Estate Settlement Procedures Act (Regulation X): 
Escrow Accounting Procedures

AGENCY: Office of the Assistant Secretary for Housing-Federal Housing 
Commissioner, HUD.

ACTION: Proposed rule.

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SUMMARY: This proposed rule addresses three problems that have arisen 
in applying HUD's current escrow accounting rule under the Real Estate 
Settlement Procedures Act (RESPA), proposes a minor additional change 
to the RESPA rule, and provides public notice of certain technical 
clarifications to the rule. This proposed rule includes several 
appendices, which in the final rule are likely to be published as 
Public Guidance Documents (rather than codified appendices), in the 
interests of regulatory streamlining. However, these materials are set 
forth in this proposed rule as appendices, for the convenience of 
commenters during the review period.
    The first problem addressed in this rule involves the application 
of requirements respecting the method of servicers' disbursements from 
mortgage escrow accounts where the payee (i.e., the entity to which 
escrow items are owed, such as a taxing jurisdiction) offers a choice 
of disbursements on an annual or installment basis. Because of 
perceived ambiguities in the current rule, there have been disparities 
in performance among mortgage servicers. Some servicers switched to 
making annual disbursements for escrow items, such as property taxes, 
where discounts for these payments were available, while other 
servicers switched to installment disbursements for items where 
installments were allowed. The choice of disbursement methods has 
consequences for borrowers, including increasing or decreasing the 
amounts required to be deposited into the escrow account at closing and 
during the life of the escrow account. The disbursement method may also 
have income tax ramifications, depending on the timing of disbursements 
for deductible items. Because of these consequences, this rule proposes 
several alternatives for addressing this problem, including, as the 
preferred option, offering the borrower the choice of disbursement 
method.
    The second problem involves cases where the servicer anticipates 
that disbursements for items such as property taxes will increase 
substantially in the second year of the escrow account. Because HUD's 
current escrow rule provides for calculating escrow payments based on 
the projection of escrow disbursements for a 12-month period, when 
escrow items increase substantially after the initial 12-month period, 
the result could be that the servicer may require of the borrower a 
substantial increase in monthly payments for the second year, not only 
to reflect the higher disbursements, but to make up a deficiency or 
shortage in the escrow account. To avoid this type of surprise for the 
borrower, who may not be prepared to make the higher payments, the rule 
proposes several solutions to this problem, including, as a preferred 
option, offering the borrower the choice at closing of how the account 
is to be calculated.
    A third problem that this rule proposes to address, in the interest 
of avoiding confusion, is the means of disclosure on the HUD-1 and HUD-
1A settlement forms of amounts required for the escrow account. HUD is 
also proposing a minor additional change to the RESPA rule and is 
clarifying existing regulations regarding matters that do not require 
substantive modifications to the regulatory language.

DATES: Comment due date: November 4, 1996.

ADDRESSES: Interested persons are invited to submit comments regarding 
this proposed rule to the Rules Docket Clerk, Office of General 
Counsel, Room 10276, Department of Housing and Urban Development, 451 
Seventh Street, SW, Washington, DC 20410-0500. Communications should 
refer to the above docket number and title. Facsimile (FAX) comments 
are not acceptable. A copy of each communication submitted will be 
available for public inspection and copying between 7:30 a.m. and 5:30 
p.m. weekdays at the above address.

FOR FURTHER INFORMATION CONTACT: David R. Williamson, Director, Office 
of Consumer and Regulatory Affairs, Room 5241, telephone 202-708-4560; 
or, for legal questions, Richard S. Bennett, Attorney; Grant Mitchell, 
Senior Attorney for RESPA; or Kenneth A. Markison, Assistant General 
Counsel for GSE/RESPA, Room 9262, telephone 202-708-3137 (these are not 
toll-free telephone numbers). For hearing- and speech-impaired persons, 
these telephone numbers may be accessed via TTY (text telephone) by 
calling the Federal Information Relay Service at 1-800-877-8339 (toll-
free). The address for each of these persons is: Department of Housing 
and Urban Development, 451 Seventh Street, SW, Washington, DC 20410-
0500.

SUPPLEMENTARY INFORMATION:

I. Background

    Section 10 of the Real Estate Settlement Procedures Act of 1974 
(RESPA) (12 U.S.C. 2609) establishes the statutory limits on the 
amounts that mortgage servicers 1 may require a borrower to 
deposit into an escrow account if the servicer chooses to establish 
one. (RESPA does not require the use of escrow accounts.) Section 
10(a)(1) prohibits a servicer, at the time the escrow account is 
created, from requiring the borrower to make payments to the escrow 
account that exceed the maximum amounts calculated in accordance with 
the statute. These maximum amounts are calculated by analyzing how much 
money will be needed to cover disbursements for the mortgaged property, 
such as taxes and insurance, and to maintain a cushion no greater than 
one-sixth of the estimated total annual disbursements from the account. 
Section 10(a)(2) prohibits the lender, over the rest of the life of the 
escrow account, from requiring the borrower to make payments to the 
escrow account that exceed the amounts allowed under RESPA. The maximum 
monthly amount that may be collected from the borrower is equal to one-
twelfth of the total annual escrow disbursements that the lender 
reasonably anticipates paying from that account during a year, plus the 
amount necessary to maintain the one-sixth cushion. No provision of 
Section 10 requires that the servicer collect the maximums allowable 
under the statute; the servicer may always collect less and is not 
required to collect any cushion at all.
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    \1\ At times RESPA uses the term ``lender'' and at other times 
it uses the term ``servicer.'' A lender creates a loan obligation, 
but may or may not service the loan. Within this proposed rule, HUD 
uses the term ``servicer'' to include the lender when the lender 
performs the servicing function.
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    Section 10 and section 6(g) of RESPA (12 U.S.C. 2605(g)) govern the 
timing of disbursements from escrow accounts. In choosing a 
disbursement date, section 10 requires that the servicer follow 
``normal lending practices of the lender and local custom, provided 
that the selection of each such date constitutes prudent lending 
practice.'' Section 6(g)

[[Page 46512]]

requires servicers to ``make payments from the escrow account for such 
taxes, insurance premiums, and other charges in a timely manner as such 
payments become due.''
    On October 26, 1994 (59 FR 53890) (October 1994 rule), HUD 
published a final rule implementing sections 6(g) and 10 of RESPA and 
changes to RESPA made in section 942 of the National Affordable Housing 
Act (Pub. L. 101-625, approved November 28, 1990). The effective date 
of this rule was extended to May 24, 1995, as a result of a February 
15, 1995, rulemaking (60 FR 8812), which also modified and clarified 
the October 1994 rule, because of questions on the rule. HUD issued 
further clarifications and corrections on December 19, 1994 (50 FR 
65442); March 1, 1995 (60 FR 11194); and May 9, 1995 (60 FR 24734), and 
published a notice of software availability on April 4, 1995 (60 FR 
16985). Further, HUD's RESPA regulations were streamlined on March 26, 
1996 (61 FR 13232) to comply with the President's regulatory reform 
initiatives.
    Today, HUD is proposing a rule primarily to address three problems 
under HUD's existing escrow accounting procedures. These problems, 
explained in greater detail below, are designated for purposes of 
discussion as:
    1. Annual vs. Installment Disbursements;
    2. Payment Shock; and
    3. Single-item Analysis with Aggregate Adjustment.
    These problems were brought to HUD's attention by borrowers, 
members of Congress, local government officials, and industry 
representatives.
    This proposed rule is consistent with three principles articulated 
by the Secretary in the preamble to the October 1994 rule:
    (1) Reduce the cost of homeownership, by ensuring that funds are 
not held in escrow accounts in excess of the amounts that are necessary 
to pay expenses for the mortgaged property and allowed by law;
    (2) Establish reasonable, uniform practices for escrow accounting; 
and
    (3) Provide servicers with clear, specific guidance on the 
requirements of Section 10.
    With respect to the first two identified problems, HUD is proposing 
to revise the escrow rules in ways that would give borrowers more 
choices. For these two problems, HUD is proposing to require that 
disclosures be given to borrowers so that they can make informed 
choices as to their preferences. The proposal would require escrow 
accounts to be maintained according to those preferences. At the same 
time, HUD recognizes that providing borrowers this choice may impose 
additional burdens and costs on servicers, which are frequently passed 
on to borrowers. Thus, this proposed rule also highlights approaches 
that have been proposed by industry representatives. HUD seeks comments 
on all approaches and is also asking a number of questions that are 
designed to help HUD make decisions among alternatives for the final 
rule.

II. Annual vs. Installment Disbursements

A. Statement of Problem

    The first problem HUD is proposing to address arises when a 
servicer is confronted with the option of disbursing escrow items, such 
as taxes, either in an annual lump sum or in installments during the 
year. In general, payments from an escrow account in installments work 
to the borrower's benefit, because, on average, they result in lower 
up-front payments to establish the account (i.e., lower closing 
costs).2 However, sometimes payees offer a discount to the 
borrower if disbursements are made on an annual basis. These discounts 
are most commonly offered by taxing jurisdictions, which may offer a 
discount for annual payments of property taxes.
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    \2\ The choice of installment, rather than annual, disbursements 
often results in substantial reductions in up-front cash 
requirements for the buyer. For example, if two equal installments 
could be paid 6 months apart instead of paying the entire bill on 
one of the installment dates, then homebuyers who close on their 
loans less than 6 months before the date on which the entire bill 
would otherwise have been due could come to settlement with 6 months 
less in tax deposits to the escrow account. This results from the 
accrued taxes being a half-year's taxes less for those homebuyers. 
Assuming closings are evenly distributed throughout the year, 
households with the option of two equal installment payments 6 
months apart, will, on average, be able to reduce the average up-
front cash required at settlement by 3-months' worth of taxes. In 
general, as the number of installments grows, so does the average 
up-front savings.
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    After publication of HUD's October 1994 rule (discussed below in 
this preamble), many servicers who had been disbursing escrow payments 
in installments switched to annual disbursements where discounts were 
available. There were many consequences of the switch that have been 
described to HUD, and other consequences that HUD speculates may have 
resulted.
    Most of these actual or expected consequences would affect 
borrowers, and it is borrowers who have expressed the greatest concern 
about this problem. After HUD issued the escrow rule, some borrowers 
may have been required by their servicers to make up substantial 
shortages in their escrow accounts (generally in increased monthly 
payments over a year), which arose when taxes were switched from 
installment disbursements to one annual lump sum disbursement. Some 
borrowers with loans that were switched from installments to annual 
disbursement may have faced financial hardship in meeting the higher 
payments. Some borrowers may have believed that the outlay to make up 
the shortage created with the switch to annual disbursements simply was 
not worth the discount offered. Other borrowers who were applying for 
loans may have been unable to come up with the cash required to close 
as a result of the escrow account being calculated based on annual 
disbursements instead of installments.
    In contrast, some borrowers whose servicers switched from annual to 
installment disbursements may have preferred to pay more at closing or 
to have disbursements from an existing escrow account paid in annual 
disbursements, in order to receive a discount and thereby reduce the 
overall amount paid or to accelerate property tax deductions on their 
income tax. Some of these borrowers may have lost a significant portion 
of their property tax deductions for the year in which the switch was 
made and may have been unhappy with that consequence.
    Of course, although some borrowers may have been adversely affected 
by a change in disbursement method, there may have been others who 
benefited, perhaps unknowingly, from such a change. For example, a 
change from installment to annual disbursements to take advantage of a 
discount lowered the total tax burden for many homeowners. Similarly, a 
change from annual to installment disbursements resulted in lower 
escrow payments and, possibly, refunds for many homeowners. HUD has not 
heard much about these positive effects. Finally, for many borrowers, 
HUD's rules apparently have not resulted in any change to the 
disbursement method for their escrow accounts.
    Some taxing jurisdictions may also have been adversely affected by 
a change in disbursement method. As a result of the servicers changing 
from annual to installment disbursements, some taxing jurisdictions may 
have faced an unexpected temporary shortfall in receipts of property 
taxes. Other taxing jurisdictions may have found that servicers changed 
from installment payments to annual disbursements; this could have 
resulted in unexpected

[[Page 46513]]

changes to receipts of property taxes or could have led to shortfalls 
in income tax receipts as deductions increased for the year the switch 
was made.
    HUD recognizes that promulgating new rules that result in switching 
accounts from one disbursement method to another could again affect 
borrowers and taxing jurisdictions and is seeking a way to clear up the 
problem that resulted from the prior rule while minimizing any further 
disruption.

B. HUD's Current Regulations

    HUD's regulation at 24 CFR 3500.17(k)(1) provides: ``In calculating 
the disbursement date, the servicer shall use a date on or before the 
earlier of the deadline to take advantage of discounts, if available, 
or the deadline to avoid a penalty.'' See also Secs. 3500.17(b) 
(definition of ``disbursement date''), 3500.17(c)(2) and (c)(3), and 
3500.17(d)(1)(i)(A) and (2)(i)(A). Some mortgage servicers have 
interpreted this rule to require that a servicer, when offered an 
option of making a disbursement from the escrow account in installments 
or in an annual disbursement with a discount, choose the lump sum 
annual disbursement with a discount, no matter how small the discount 
is, even if the borrower and the servicer would otherwise agree to 
forego the discount and have the escrow account computed for 
disbursements on an installment basis.
    On the other hand, other servicers have interpreted HUD's rule, in 
light of preamble language, to require installments where available and 
allow, but not require, annual disbursement at the servicer's 
discretion where a discount is offered for annual disbursement.3 
This approach is in keeping with HUD's intention that the regulations 
generally favor installment payments, because in many cases they result 
in lower up-front payments and lower average escrow balances for the 
borrower. HUD also sought for servicers to take advantage of discounts 
that would benefit borrowers.
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    \3\ The preamble to the October 1994 rule explained, ``Unless 
there is a discount to the borrower for early payments, the 
regulation does not allow servicers to pay installment payments on 
an annual or other prepayment basis.'' 59 FR 53893.
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    In response to further questions on this issue, HUD indicated in 
its February 1995 clarifications of the rule that the rule's focus had 
been to deal ``with a practice, previously engaged in by some 
servicers, of collecting and paying a full-year's taxes in advance, 
although they were billed on an installment basis.'' 59 FR 8813. In the 
preamble to a May 1995 rule, HUD stated that ``servicers were permitted 
(but not required) to make disbursements on an annual basis if a 
discount were available.'' The preamble explained:

    [T]he Department received a number of questions regarding 
circumstances in which the payee offered an option of either 
installment payments or a one-time payment with a discount. The 
preamble to the October 26, 1994, and February 15, 1995, rules 
indicated that when a choice was available, servicers should make 
disbursements on an installment basis, rather than an annual basis; 
however, servicers were permitted (but not required) to make 
disbursements on an annual basis if a discount were available. Once 
the choice of payment basis is made, the disbursement date chosen 
for that basis depends on discount and penalty dates. Section 
3500.17(k) states that ``[i]n calculating the disbursement date, the 
servicer shall use a date on or before the earlier of the deadline 
to take advantage of discounts, if available, or the deadline to 
avoid a penalty.'' This provision is consistent with the rule, which 
is designed to avoid excessive upfront payments and balances in 
escrow accounts and, therefore, favors installment payments, unless 
there are penalties or discounts that make annual payments 
advantageous for the consumer. Also, after settlement a servicer and 
borrower are not prevented by this rule from mutually agreeing, on 
an individual case basis, to a different payment basis (installment 
or annual) or disbursement date.

60 FR 24734.
    HUD recognizes that the rule text and the preamble language may 
have created confusion. Until such time as HUD publishes a final rule 
on this subject, servicers should adhere to the following approach, 
consistent with HUD's prior guidance: Where a payee offers the option 
of installment disbursements or a discount for annual disbursements, 
the servicer should make disbursements on an installment basis, but 
may, at the servicer's discretion (but is not required by RESPA to), 
make annual disbursements, in order to take advantage of the discount 
for the borrower; HUD encourages (but does not require) servicers to 
follow the preference of the borrower. Where the payee offers the 
option of either annual disbursements with no discount or installment 
payments, the servicer is required to make installment payments.

C. Possible Revisions to Regulations to Address Problem

    There are several rulemaking alternatives to address whether 
servicers are to make installment or annual disbursements. These 
alternatives propose to distinguish between escrow accounts for loans 
that settle on or after the effective date of a final rule and escrow 
accounts for loans that settle or settled before the effective date of 
a final rule.
    Each alternative proposes that once a disbursement method has been 
selected in accordance with the requirements of the alternative, 
servicers would be prohibited from switching disbursement methods 
without the borrower's consent. This would mean that even where one 
servicer acquires servicing from another servicer, the second servicer 
would be required to apply the same disbursement method as the first 
servicer, as long as that option is offered by the payee, unless the 
borrower consents to changing disbursement methods. The reason for this 
approach is that many loans shifted disbursement dates as a result of 
the 1994 rule. HUD seeks to develop an approach with the minimum 
negative impact for borrowers, servicers, and third parties, such as 
taxing jurisdictions. HUD is concerned that, if the approach adopted 
results in a large number of additional shifts in the way escrows are 
disbursed, HUD will create new problems while attempting to solve old 
ones. HUD believes the approach proposed, if ultimately adopted, would 
be the approach that would minimize disruption.
    If borrowers could be involuntarily switched from annual 
disbursements to installment disbursements as a result of a transfer of 
servicing or unilateral change by the servicer, some borrowers would 
face consequences they did not desire. A switch could result in a 
surplus that a servicer would be required to return to a borrower, but 
could also reduce the amount of the borrower's tax deduction for escrow 
items, such as property taxes, in the year of the switch. If a borrower 
could be involuntarily switched from installment disbursements to 
annual disbursements as a result of a transfer of servicing or 
unilateral change by the servicer, the transfer or change could 
increase the tax deductions for escrow items such as property taxes in 
the year of the switch, but could result in shortages for many 
borrowers.
    The approach of prohibiting a servicer from switching disbursement 
methods without the borrower's consent, including requiring a servicer 
to use the disbursement method used by the former servicer when there 
is a transfer of servicing, does not mean that the borrower would have 
to consent to a transfer of servicing or would have veto authority over 
such a transfer. Transfer of servicing is governed by section 6 of 
RESPA and regulations at 24 CFR 3500.21. However, this approach would 
mean that a borrower would have to consent to a change in the 
disbursement

[[Page 46514]]

method, including a change proposed by a subsequent servicer. HUD seeks 
comments on whether this policy would adversely affect the value, and 
efficiency of the transfer, of servicing rights.
    This proposed rule contains the main substance of proposed rule 
language to implement the various alternatives discussed. Additional 
conforming amendments to the rule, appropriate to whichever alternative 
is ultimately adopted, would be required.

Alternative 1: Consumer Choice

    New loans. For escrow accounts on any loan closed on or after the 
effective date of a final rule, servicers would be required to give 
borrowers the choice of making disbursements of property taxes on an 
installment or on an annual basis, when those options are offered by 
the taxing jurisdiction. HUD's proposal does not currently address the 
choice between installments and annual disbursements for other escrow 
items, because the question has only been raised to HUD in the context 
of property taxes; however, HUD would consider addressing other escrow 
items, depending on comments received.4
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    \4\ If the servicer is given a choice between installment or 
annual disbursements for other escrow items (such as property or 
hazard insurance), HUD's rule would require the servicer to make 
disbursements by a date that avoids a penalty, but the servicer 
would otherwise be free to make disbursements on such date as 
complies with normal lending practice of the lender and local 
custom, provided that the selection of each such date constitutes 
prudent lending practice.
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    This alternative would require servicers, at some time before 
settlement, to provide a disclosure form (in the format of Appendix F) 
to borrowers whose property taxes will be paid from an escrow account 
and whose taxing jurisdictions offer the choice between disbursements 
on an installment or an annual basis. The form indicates some of the 
advantages and disadvantages to the borrower of installment and annual 
disbursements and asks the borrower to make a choice between the two 
methods. If the borrower does not make a choice, the servicer will be 
required to make installment disbursements of property taxes.
    This alternative also provides that once the consumer has made a 
choice (or installments are required because the consumer has failed to 
make a choice), the servicer and subsequent servicers are prohibited 
from changing the method of disbursement for property taxes, as long as 
the taxing jurisdiction offers a choice, without the borrower's prior 
written consent.
    Existing loans. For loans that settled prior to the effective date 
of a final rule, the servicer and subsequent servicers would be 
prohibited from changing the method of disbursement for property taxes 
without the borrower's prior written consent where the taxing 
jurisdiction offers a choice between installments and annual 
disbursements. In addition, no later than the first escrow analysis for 
such escrow accounts performed after the effective date of a final 
rule, servicers would be required to offer borrowers, in writing, an 
opportunity to switch from one method of disbursement for property 
taxes to another.
    This approach provides the greatest flexibility to the borrower. 
However, it may impose higher costs on servicers; servicers will likely 
need two different disbursement systems to reflect the disbursement 
preferences of borrowers.

Alternative 2: Servicer Flexibility

    Under this alternative, HUD would revise the rule to provide that a 
servicer must make disbursements by a date that avoids a penalty, but 
the servicer is otherwise free to make disbursements on such date as 
complies with normal lending practice of the lender and local custom, 
provided that the selection of each such date constitutes prudent 
lending practice. Under this alternative, once the servicer has made a 
choice of the disbursement method, the servicer and subsequent 
servicers are prohibited from changing the method of disbursement, as 
long as a choice continues to exist in the taxing jurisdiction, without 
the borrower's prior written consent.
    The benefit of this alternative is that it is the least-intrusive 
regulatory approach for HUD to take. In addition, it provides 
flexibility to servicers. This alternative would also leave servicers 
free to accommodate borrowers with a particular preference, as long as 
the borrower's preference is in accordance with normal lending practice 
of the lender and local custom and constitutes prudent lending 
practice. The disadvantage of this alternative is that it would not 
guarantee that servicers would accommodate the preferences of 
individual borrowers and, therefore, provides less choice for 
borrowers.

Alternative 3: Keep, But Clarify, Current Requirements

    Under this alternative, HUD would clear up any inconsistencies 
between the regulatory text and the earlier preamble language that have 
created confusion, as discussed above in this preamble. The rule would 
be revised to provide that, generally, servicers must make 
disbursements from escrow accounts on an installment basis, where 
payees offer that option as an alternative to annual disbursements. 
Where a payee offers the option of installment disbursements or a 
discount for annual disbursements, the servicer may, at the servicer's 
discretion (but would not be required as a result of RESPA to), make 
annual disbursements, in order to take advantage of the discount for 
the borrower. Where the payee offers the option of annual disbursements 
with no discount or installment payments, the servicer would be 
required to make installment payments. Where a payee offers the option 
of installment disbursements or a discount for annual disbursements, 
the rule would provide that HUD encourages (but does not require) 
servicers to follow the preference of the borrower on whether to make 
disbursements on an annual or installment basis.
    In addition, the servicer and subsequent servicers are prohibited 
from changing the method of disbursement, as long as a choice continues 
to exist in the taxing jurisdiction, without the borrower's prior 
written consent.
    The advantage of this option is that, like Alternative 2 (discussed 
above in this preamble), it provides flexibility to servicers. It would 
also allow servicers to accommodate borrowers with a particular 
preference. The disadvantage of this alternative is that it would not 
guarantee that servicers would accommodate the preferences of 
individual borrowers, providing less choice for borrowers.

D. Questions for Commenters

    While the description of each alternative discussed under the 
heading ``Annual vs. Installment Disbursements'' in this preamble, 
indicates some of the possible advantages and disadvantages, there 
could be other alternatives, as well as unanticipated negative 
consequences for the industry, borrowers, taxing authorities, or 
others. HUD seeks comments from the public on which, if any, of these 
alternative approaches should result from this rulemaking, or whether 
other permissible approaches under RESPA would better serve the 
interests of the public and the intent of the statute. HUD also invites 
commenters to comment on HUD's proposed regulatory language and to 
submit specific regulatory language to implement their proposals.
    HUD is particularly interested in comments on the following issues:
    1. How are servicers currently addressing the problem of setting 
the appropriate disbursement date when

[[Page 46515]]

given a choice of annual or installment disbursements?
    2. What would be the impact of changing the requirements on 
particular servicers operating under existing RESPA regulations, 
particularly with respect to any changes in the requirements for loans 
settled before the effective date of a final rule?
    3. What are the discounts obtained by servicers for borrowers? How 
large are the discounts? When must disbursements be made in order to 
receive the discounts?
    4. What would be the impact on servicers of requiring them to 
provide borrowers with a choice? Should this be limited to a one-time 
choice at closing or should the borrower be free to switch disbursement 
methods during the life of the loan, and, if so, how often and under 
what circumstances?
    5. What are the relative benefits and disadvantages of an approach 
that treats loans that settle on or after the effective date of a final 
rule differently from loans that have settled before the effective date 
of a final rule--e.g., minimizing the need for a servicer to switch 
from one method to another for existing loans, but potentially 
requiring servicers to use different disbursement methods for different 
borrowers within a single taxing authority?
    6. Should the size of an available discount matter and, if so, how? 
Should HUD provide that once the discount meets a certain percentage or 
other threshold that: (a) Annual disbursements with a discount must be 
used; (b) it becomes the borrower's choice whether to make 
disbursements in that manner; or (c) it becomes the servicer's choice 
whether to make disbursements in that manner? Should the threshold that 
determines whether to take the discount be tied to a particular market 
rate that varies over time, e.g., some percentage above or below the 
discount rate, the rate on 3-month Treasury Bills, etc.? Should a 
``reasonable servicer'' standard be applied, i.e., allowing a servicer 
to choose whether to take advantage of the discount if a reasonable 
person would make such a decision with his or her own money?
    7. If an approach is adopted in which the borrower's preference for 
installments or annual disbursements is controlling, when should the 
servicer give the borrower the disclosure? If the borrower is required 
to designate which option is preferred before loan approval, how can 
the borrower be protected from pressure to select an option that is 
merely the lender's preference and not necessarily in the borrower's 
best interest? Because the method selected could affect escrow payments 
due at closing and each month thereafter, what timing would be 
necessary for the servicer to prepare the closing documents and perform 
related work? How will the option selected affect underwriting?
    8. If an approach is adopted in which the borrower's preference for 
installments or annual disbursements is controlling, should HUD 
prescribe a disclosure format as proposed? Is the information HUD 
proposes to provide on the disclosure format appropriate for providing 
the borrower with a fair and informed choice?
    9. If an approach is adopted in which the borrower's preference for 
installments or annual disbursements is controlling, what period of 
time is needed for the servicer to change the disbursement method?
    10. The issue of annual or installment disbursements most often 
arises in the context of property taxes. If an approach is adopted in 
which the borrower's preference for installments or annual 
disbursements is controlling, should this approach apply only to 
disbursements for property taxes, as proposed, or should it extend to 
other escrow items for which a choice between installments and annual 
disbursements may be offered? What should be the rule for other escrow 
items when a choice is offered?
    11. What rules should apply to loans that settle before the 
effective date of a final rule? What rules should apply to loans that 
settle after the effective date of the final rule, once those loans 
have settled? What rules should apply when there is a transfer of 
servicing?

III. Payment Shock

A. Statement of Problem

    Another problem HUD is proposing to address arises when 
disbursements for escrow items such as property tax disbursements are 
expected by the servicer to be much higher in the second year of the 
escrow account than in the first year. As a result, the borrower will 
be faced with a substantial increase in the monthly escrow payment 
during the second year and, possibly, a lump sum payment to eliminate a 
deficiency from the account.5 For purposes of this rule, a 
substantial increase is defined as an increase of 50 percent or more in 
the monthly escrow payment between the payment under the initial escrow 
accounting and the payment in the second year of the escrow account. A 
substantial increase in property taxes in the second year often occurs 
in cases of new construction. In many jurisdictions, the taxes the 
locality charges for the first year are based on the assessed value of 
the unimproved property, while for the second year the taxes are based 
on the improved value. A substantial increase in payments may also 
occur where a tax disbursement that would normally appear on the 
projection for the coming year is paid prior to the borrower's first 
regular payment, i.e., these regularly occurring taxes do not appear in 
the projection. Reassessments after a property is sold may also cause a 
substantial second year increase. While the servicer could alert the 
borrower at closing that an increase will occur, if the servicer does 
not, the borrower may be unpleasantly surprised by the increase.
---------------------------------------------------------------------------

    \5\ The increase in the monthly payment can be broken down into 
two components. Any time an escrow account disbursement increases, 
it will have the effect of raising the monthly borrower escrow 
payment by approximately one-twelfth of that increase. In addition, 
the projection for the coming year shows what the target balance 
(accruals plus the cushion) should be at the beginning of the coming 
year. To the extent that expected disbursements in the second year 
exceed what they were in the first, the beginning target balance for 
the second year may be in excess of the actual balance at the end of 
the first year. If so, then there is a shortage to be made up as 
well. If the 12-month approach is taken to eliminate the shortage, 
then monthly payments will also rise by approximately one-twelfth of 
the shortage. If a cushion is used, the payment increases will be 
slightly higher, until the cushion is built up.
---------------------------------------------------------------------------

    This situation results in several problems. Disclosures received at 
closing show low payment amounts throughout the first year when, in 
fact, the escrow payment will substantially increase for the second 
year, or even during the first year if a short year statement is issued 
at the point when the higher disbursement shows up in the 12-month 
projection.6 Some borrowers may be unable to meet the increased 
escrow payments because the shortage will raise payments even more. A 
customer relations issue may be created for servicers who have to 
explain to borrowers why the payment is increased so much.
---------------------------------------------------------------------------

    \6\ HUD regulations at 24 CFR 3500.17(f)(1) (i) and (ii) provide 
that, aside from conducting an escrow account analysis when an 
escrow account is established and at completion of the escrow 
account computation year, a servicer may conduct an escrow account 
analysis at other times. The escrow account analyses conducted at 
other times result in short-year statements.
---------------------------------------------------------------------------

    These concerns have come largely from industry representatives who 
have responded to numerous borrower inquiries and complaints about 
increases in escrow payments to reflect higher disbursements and make 
up shortages. Mortgage servicers have indicated that they would like to 
avoid any payment change in subsequent years by collecting more money 
in the first year of servicing.

[[Page 46516]]

B. Analysis Under HUD's Current Regulations

    Consistent with Section 10 of RESPA, HUD regulations specify the 
maximum amount that a servicer may legally require borrowers to deposit 
in escrow accounts. HUD regulations prescribe that in conducting an 
escrow account analysis, the servicer considers only the disbursements 
that are expected to come due for a 12-month period. See, e.g., 
Secs. 3500.17(b) (definition of ``escrow account computation year'') 
and 3500.17(c) (limits on payments to escrow accounts). While the 
servicer can take into account expected changes to disbursements over 
the 12-month period,7 even if the servicer knows that payments 
from an escrow account will substantially increase at a time more than 
12 months in the future, the servicer cannot, when preparing the 
initial escrow account statement, calculate the borrower's payments to 
cover the expected increases. However, HUD's existing regulations 
(3500.17(f)(1)(ii)) allow the servicer to perform short year 
statements. The regulations also allow borrowers to make additional 
escrow payments voluntarily to avoid a shortage in the following year. 
HUD's existing regulations provide that if the borrower makes such 
additional payments, they must normally be returned to the borrower if 
they result in a surplus the next time the escrow account analysis is 
performed. See 59 FR 53893 (voluntarily escrowed funds not excluded 
from the trial running balance calculations).8 If the additional 
payments do not result in a surplus the next time the escrow account 
analysis is performed (i.e., where disbursements will substantially 
increase), the additional payments do not have to be returned to the 
borrower.
---------------------------------------------------------------------------

    \7\ HUD's current regulations address the issue of estimating 
disbursement amounts for the 12-month computation year:
    To conduct an escrow account analysis, the servicer shall 
estimate the amount of escrow account items to be disbursed. If the 
servicer knows the charge for an escrow item in the next computation 
year, then the servicer shall use that amount in estimating 
disbursement amounts. If the charge is unknown to the servicer, the 
servicer may base the estimate on the preceding year's charge as 
modified by an amount not exceeding the most recent year's change in 
the national Consumer Price Index for all urban consumers (CPI, all 
items). In cases of unassessed new construction, the servicer may 
base an estimate on the assessment of comparable residential 
property in the market area.

    24 CFR 3500.17(c)(7).
    \8\ Surpluses generated by voluntary borrower prepayments 
(frequently of principal, interest, and escrow account amounts) do 
not constitute a violation of the escrow account limits, even if 
they remain in the account in the next escrow account computation 
year. 60 FR 8813.
---------------------------------------------------------------------------

C. Possible Revisions to Regulations to Address Problem

    There are many possible ways to respond to the Payment Shock 
problem identified. Just as in the case of the Annual vs. Installment 
Disbursements problem discussed above in this preamble, the Secretary 
believes that providing the consumer with information to make an 
informed choice, and allowing the consumer's choice to control, is 
likely the best approach for addressing this problem. Set forth below 
are three alternatives, some of which contain options within the 
alternatives. This proposed rule contains the main substance of 
proposed regulatory language to implement the various alternatives 
discussed. Additional conforming amendments to the regulations would be 
required, consistent with whichever alternative is ultimately adopted.

Alternative 1: Consumer Choice

    Under this alternative, when the servicer expects that the bills 
paid out of the escrow account will increase substantially after the 
first year, the servicer would provide to the borrower, at some time 
prior to closing, a written disclosure in the format of appendix G to 
this proposed rule or a similar format. The borrower would make a 
choice from several accounting options for his or her account on a 
format that would indicate, under each option, the amount due at 
closing; the monthly escrow payments in the first, second, and third 
years; and the corresponding surpluses anticipated at the end of the 
first year.9 The borrower would therefore have the opportunity to 
make a voluntary choice to limit payment changes in the second year of 
the escrow account. As would be explained on the disclosure format, if 
the borrower did not make a choice, the accounting method would 
``default'' to the method prescribed under the current regulations 
(which may result in substantially increased payments in the second 
year). Once an escrow accounting method is selected by choice or 
default, that method may not be changed without the consent of the 
borrower, even if the servicing rights are transferred to another 
servicer.
---------------------------------------------------------------------------

    \9\ Whether disbursements from escrow accounts will be made on 
an annual or installment basis and whether there is a discount for 
annual disbursement will affect the numbers to be filled in and, 
potentially, the number of calculations on the Escrow Accounting 
Method Selection Format.
---------------------------------------------------------------------------

    Under this alternative, the following accounting methods 
(illustrated in ``The Payment Shock Problem,'' Appendix H-1 to this 
proposed rule) would be presented to the borrower for his or her 
selection:
    Method A. Analysis of the account using the accounting method 
required under the current rule, which results in a shortage at the end 
of the first year and higher payments in the second year.
    Method B. Analysis of the account using an accounting method that 
has the following characteristics:

--Requires an initial deposit of $0 into the escrow account at closing;
--Requires a monthly payment in the first year equal to one-twelfth of 
the estimated total annual disbursements from the escrow account for 
the second year;
--Causes surpluses or smaller shortages at the end of the first year, 
which causes escrow payments to increase in the second year less than 
under Method A or not at all.

    Method C. Analysis of the account using an alternative accounting 
method 10 that has the following characteristics:

    \10\ The Mortgage Bankers Association indicated to HUD that it 
favors this alternative in correspondence to HUD dated April 10, 
1996.
---------------------------------------------------------------------------

--Requires an initial deposit into the escrow account at closing 
greater than the initial deposits required under Method B;
--Requires the same monthly payment during the first year as under 
Method B, which is greater than under Method A;
--Generates month-end balances such that the lowest month-end balance 
for the first year equals one-sixth of the estimated total annual 
disbursements for the second year (the initial deposit is not 
considered in finding the lowest month-end balance);
--Requires an initial deposit into escrow at closing greater than the 
initial deposits required under Method B;
--Generates even larger balances at the end of the first year than 
under Method B, eliminating shortages and increasing surpluses that 
must be returned to the borrower;
--Causes no increase in escrow payments in the second year.

    Note: If the consumer selects Methods B or C, the amounts held 
in escrow could be greater than allowed under Section 10. In order 
to permit these options, the Secretary would invoke his exemption 
authority under section 19(a) of RESPA, 12 U.S.C. 2617.

Alternative 2: Make No Change

    Under this alternative, even where the servicer expects that the 
bills paid out of the escrow account will increase substantially after 
the first year, the current requirements for escrow

[[Page 46517]]

analysis would continue to apply. This alternative would not 
specifically prevent the problems of shortages at the end of the first 
year of the escrow account and substantial escrow payment increases in 
the second year as a result of large increases in escrow disbursements 
during the second year of servicing. However, under the existing rule, 
servicers may disclose the problem to borrowers, and borrowers may make 
voluntary overpayments to escrow accounts. Servicers may also calculate 
short-year statements. Thus, under the existing rule, some methods are 
available to alleviate the payment shock problem, although they are not 
required.

Alternative 3: Mandate First Year Overpayment

    Under this alternative, when the servicer expects that the bills 
paid out of the escrow account will increase substantially after the 
first year, HUD would require the servicer to calculate the escrow 
account under a procedure that has the characteristics described under 
Alternative 1, Method C, described above (illustrated in ``The Payment 
Shock Problem,'' Appendix H-2 to this proposed rule). This approach 
would result in requiring amounts held in escrow to be greater than 
allowed under Section 10. The Secretary could, however, mandate the use 
of this escrow accounting method pursuant to his exemption authority 
under section 19(a) of RESPA, 12 U.S.C. 2617.

D. Questions for Commenters

    HUD seeks comments from the public on which, if any, of these 
alternative approaches should result from this rulemaking, or whether 
other permissible approaches would better serve the interests of the 
public and the intent of the statute. Other possible alternatives on 
which HUD would welcome comment include:
    1. As variations on Alternative 2, either:
    (A) Require servicers to disclose to borrowers that it is 
anticipated that they will have a substantial payment increase in the 
second year, so borrowers will be less surprised when such an increase 
occurs, but do not require servicers to indicate specifically to 
borrowers methods of avoiding the shortage; or
    (B) Require servicers to disclose to borrowers that it is 
anticipated that they will have a substantial payment increase in the 
second year and to inform borrowers of the amount of the expected 
shortage at the end of the first year and of the opportunity to make 
additional payments to escrow ahead of schedule to avoid Payment Shock.
    2. As a variation on Alternative 1, Method C, calculate the cushion 
as one-sixth of the estimated annual disbursements for the first year, 
instead of 2 months of the escrow payments for the first year.
    3. For each new account for which it is anticipated that there will 
be a substantial payment increase in the second year for one or more 
escrow items, allow the servicer, with the consent of the borrower, the 
option of calculating the escrow payments on a 24-month basis. This 
would allow the servicer to look ahead to the second year and estimate 
the payment that would be due, thereby mitigating the deficiency or 
shortage after the first year, leaving a smaller deficiency or shortage 
after the second year. (Using an escrow account period of more than one 
year has precedent. See the treatment of flood insurance and water 
purification escrow funds in Sec. 3500.17(c)(9).) Under this option, 
since the amounts held in escrow would be greater than allowed under 
Section 10, it would be necessary for the Secretary to invoke his 
exemption authority under section 19(a) of RESPA, 12 U.S.C. 2617.
    HUD invites commenters to submit specific regulatory language to 
implement their proposals and to comment on HUD's proposed regulatory 
language. HUD is also interested in comments on the following issues:
    1. How are servicers dealing with payment increases in the second 
year under the current rule?
    2. How should mortgage servicers determine whether bills paid out 
of escrow accounts are expected to increase substantially after the 
first year? Is it appropriate to define a substantial increase as an 
increase of 50 percent or more in the monthly escrow payment between 
the payment under the initial escrow accounting and the payment in the 
second year of the escrow account, and is it appropriate for this 
threshold to trigger additional requirements? What method should be 
used in calculating the expected payments?
    3. What, if any, impact would there be in changing the requirements 
regarding payment increases on servicers operating under existing RESPA 
regulations?
    4. What, if any, impact would there be on servicers if they are 
required to provide borrowers a one-time choice at closing? What would 
be the impact on servicers of requiring them to provide borrowers a 
choice at other times? What would be the burden in having different 
procedures for different borrowers?
    5. If the consumer choice option is adopted, what should be the 
timing of the servicer's inquiry to the borrower and the borrower's 
response? If the borrower is required to designate before loan approval 
which option he or she prefers, would the borrower be pressured into 
selecting an option that may not be in the borrower's best interest? 
Because the method selected could affect escrow payments due at closing 
and each month thereafter, what timing would be sufficient for the 
closing agent to prepare the closing documents and perform related 
work? How would the option selected affect underwriting?
    6. If the consumer choice option is adopted, should HUD prescribe a 
disclosure format as proposed? Is the information HUD is proposing to 
provide on the disclosure format appropriate?
    7. Should there be limits on the borrower's opportunity to switch 
escrow accounting methods? How frequently should the borrower be 
allowed to change methods and under what circumstances? Should the 
borrower be allowed to make only a one-time choice at closing?
    8. Should any alternatives be offered to borrowers whose escrow 
payments are not expected to increase substantially after the first 
year?

IV. Single-Item Analysis With Aggregate Adjustment Problem

A. Statement of Problem and HUD's Current Regulations

    The October 1994 escrow rule established a uniform nationwide 
standard accounting method known as aggregate accounting. This replaced 
the common method of accounting in the industry--treating each escrow 
account item as a separate or single item. The amounts on the HUD-1 in 
the 1000 series historically were shown in a single-item mode--that is, 
the reserve amount for each separate escrow account item was listed.
    When the October 1994 rule was being developed, Federal Reserve 
Board staff indicated that it needed a single-item amount for private 
mortgage insurance (PMI) reserves in order to make annual percentage 
rate (APR) calculations under the Truth In Lending Act. For this 
reason, and in an effort to avoid altering the basic format of the HUD-
1 or HUD-1A in the October 1994 rule, the Department required that an 
aggregate adjustment (either zero or a negative number) be made after 
each individual item was listed in the 1000 series, so that the reserve 
amount for escrow account items conformed to the aggregate accounting 
method. Before the October 1994 escrow rule, Section L of

[[Page 46518]]

the HUD-1 and HUD-1A only showed positive numbers, that is, payments 
that were being allocated to various settlement costs. After 
publication of the October 1994 final rule, the Department received 
complaints that the itemization of the reserve amounts with an 
aggregate adjustment was confusing and the information was not useful 
to borrowers. Settlement agents and others indicated that individual 
itemization of reserves in the 1000 series imposed an additional 
paperwork and explanation burden, when the only relevant number for 
calculations is the aggregate deposit amount.

B. Possible Revisions to Address Problem

    This rule proposes a method of correcting the problem: HUD would no 
longer require the single-item listing of escrow deposits on the HUD-1 
or HUD-1A. The rule would create a new option in the instructions for 
the 1000 series of these forms to reflect the aggregate deposit. As 
proposed, the settlement agent could also continue to itemize the 1000-
series reserves, at the settlement agent's discretion. If the charges 
are not itemized, an asterisk (*) would have to be placed next to each 
item in the 1000 series for which a reserve is taken. The amount 
collected would be described as ``Aggregate Escrow Deposit for Items 
Marked (*) Above'' on a line at the end of the 1000 series. In the 
discussion ``Clarifications of Existing Rule'' in Part V of this 
preamble, HUD has made clear that entries on the Good Faith Estimate 
may be based on single-item analysis, with a maximum 1-month cushion. 
The rule is proposed to be amended to make clear that the use of the 
estimating method remains available after the end of the phase-in 
period (October 24, 1997).
    Federal Reserve Board staff has indicated that it generally concurs 
with this approach, inasmuch as the PMI number for APR calculations is 
otherwise available. HUD seeks comments from the public on this 
proposal, as well as other approaches that would be permissible under 
RESPA and might better serve the interests of the public and the intent 
of the statute. HUD also invites commenters to submit specific 
regulatory language to implement their proposals.

V. Additional Proposed Change

    HUD proposes to add information to the Good Faith Estimate format 
to help make purchasers of pre-1978 residential dwellings aware that, 
pursuant to 42 U.S.C. 4852d (implemented by HUD in regulations 
published on March 6, 1996, 61 FR 9064), they have the right to arrange 
for a timely paint inspection or risk assessment for the presence of 
lead-based paint or lead-based paint hazards before becoming obligated 
under a sales contract. Generally, a prospective purchaser has 10 days 
to conduct such a lead-based paint evaluation of the property. A 
prospective purchaser, however, may waive in writing the opportunity to 
conduct this evaluation. Therefore, HUD proposes to add language to the 
Good Faith Estimate format (appendix C) to reference a lead-based paint 
inspection or risk assessment and to add a reference to such 
inspections or assessments in the instructions for completing the 1300 
series of the HUD-1 or HUD-1A. HUD anticipates that a more detailed 
explanation of purchasers' rights in this regard will be contained in 
the next revision of the HUD Settlement Costs booklet.

VI. Clarifications to Existing Rule

    The following paragraphs discuss clarifications of the escrow rule 
that do not require substantive modifications to language in the 
existing provisions. These clarifications are in response to questions 
that have been raised about the escrow rule.
    (a) Question: Does the rule permit a cushion to be taken on private 
mortgage insurance (PMI) premium payments?
    Answer: Yes. Nothing in the rule distinguishes these payments from 
any other payments into the escrow account and, thus, a cushion may be 
based on such payments. The question arises because Federal Housing 
Administration (FHA) program rules do prohibit a cushion on the FHA 
Mortgage Insurance Premium (MIP), but the FHA limitation is applicable 
only to the FHA mortgage insurance.
    (b) Question: During the phase-in period under the escrow rule for 
accounts existing prior to May 24, 1995, there is an alternative 
approach permitted for disclosing potential escrow charges under 
Sec. 3500.8(c)(2), involving the use of single-item analysis with a 1-
month cushion. In the final rule of February 15, 1995 (60 FR 8812), the 
clarifications indicated that for Good Faith Estimate purposes, as well 
as for the HUD-1 or HUD-1A, a single-item analysis with a maximum 1-
month cushion is acceptable. See 60 FR at 8812 and 8813. Is the single-
item analysis with a 1-month-cushion approach acceptable on the Good 
Faith Estimate, even when the aggregate approach is subsequently used 
on the HUD-1 or HUD-1A, and will this be true after the phase-in period 
ends?
    Answer: Yes. The good faith estimate is an estimate and HUD does 
not impose strict methodologies for delivering information that 
frequently is unavailable or difficult to obtain. As long as the 
estimates are developed in good faith, the use of single-item analysis 
with a maximum 1-month cushion to establish a range or amount for Good 
Faith Estimate purposes will be acceptable. The Good Faith Estimate 
instructions in Sec. 3500.7(c)(2) are proposed to be amended to clarify 
that this method of estimation is available after the phase-in period 
has passed.
    (c) Question: Appendix E assumes that the same cushion applies to 
all escrow items. However, lenders may prefer to use, for instance, a 
2-month cushion for hazard insurance and a 1-month cushion for property 
taxes. Is that permissible?
    Answer: Yes. The rule does not require that the cushion be the same 
fraction of annual anticipated disbursements for each escrow item, 
provided, of course, that no cushion exceeds the limit of 2 months' 
disbursements.
    (d) Question: When filling out the HUD-1, it is necessary to 
calculate the aggregate adjustment so that the amount the borrower has 
to pay into the escrow account at closing will not exceed the RESPA 
limits (which are defined in terms of aggregate accounting, whereas the 
rest of the 1000 series of the HUD-1 is reported using single-item 
accounting). The aggregate adjustment is the difference between the 
deposit calculated under the aggregate accounting method and the sum of 
the deposits that would be calculated using single-item accounting. 
Must the same cushion be used when making the aggregate calculations as 
was used when making the single-item calculations?
    Answer: Yes. So, for example, if a 1-month cushion were taken for 
taxes and a 2-month cushion were taken for insurance in making the 
single-item entries, then the cushion in making the aggregate 
calculations would be the sum of one-twelfth of the projected taxes and 
one-sixth of the projected insurance.

Other Matters

Paperwork Reduction Act Statement

    The proposed information collection requirements contained in 
Sec. 3500.17 and Appendices A and C of this rule will be submitted to 
the Office of Management and Budget (OMB) for review in accordance with 
the Paperwork Reduction Act of 1995 (44 U.S.C. 3501-3520).
    (a) In accordance with 5 CFR 1320.5(a)(1)(iv), the Department is 
setting forth the following concerning the proposed collection of 
information:

[[Page 46519]]

    (1) Title of the information collection proposal: Escrow account 
tax disbursement method disclosure; escrow account tax calculation 
procedure disclosure; and changes to lines pertaining to lead-based 
paint risk assessments or inspections in settlement statements and good 
faith estimates.
    (2) Summary of the collection of information: The escrow account 
tax disbursement method disclosure will allow the consumer to choose 
whether taxes are paid on an annual, a semiannual, or other basis. The 
escrow account tax calculation procedure disclosure allows consumers to 
choose the procedure that is used to calculate the escrow account, when 
it is anticipated that the second-year charges for an item will be 
substantially higher than the first-year charges.
    (3) Description of the need for the information and its proposed 
use: (i) Escrow account tax disbursement method disclosure. The Real 
Estate Settlement Procedures Act (RESPA) at 12 U.S.C. 2609 provides for 
escrow accounts. The implementing regulations at 24 CFR 3500.17(k) 
provide that the servicer shall use as the disbursement date a date on 
or before the earlier of the deadline to take advantage of discounts, 
if available, or the deadline to avoid a penalty. Consequently, some 
lenders changed disbursement methods and some borrowers were adversely 
affected by the change. The proposed rule suggests three alternatives 
in addressing this problem. One alternative will require an escrow tax 
disbursement method disclosure which will allow the consumer to choose 
whether taxes are paid on annual, semi-annual or other basis. The other 
two alternatives do not require a new disclosure.
    (ii) Escrow account tax calculation procedure disclosure. Another 
problem the rule addresses is where the charges for an item are 
expected to be substantially higher the second year than in the first 
year. The increased charges may result in payment shock as well as a 
deficiency in the escrow account and substantially increased escrow 
payments the following year. For example, in the case of new 
construction, the real estate tax amount may be estimated on the 
unimproved value of the property. Frequently, borrowers are then 
required to pay taxes based on the improved value of the property.
    Current regulations limit the amount that the lender may require 
the borrower to deposit in an escrow account at settlement and the 
amount the lender may require the borrower to maintain in an account. 
The regulations at 24 CFR 3500.17 prescribe the method for determining 
these amounts. The proposed rule offers three alternative solutions. 
One alternative requires a disclosure that allows the consumer to 
choose the procedure for calculating escrow payments. Another 
alternative would require lenders to calculate the escrow under a new 
procedure which is also a consumer choice under the first alternative. 
Both of these alternatives would require lenders to make adjustments to 
escrow calculation software. The third alternative does not require an 
additional burden.
    (iii) Changes for lead-based paint. In addition, information is 
proposed to be added in the Good Faith Estimate format to make 
purchasers of pre-1978 residential dwellings aware that, pursuant to 42 
U.S.C. 4852d, they have the right to arrange for a lead-based paint 
inspection or risk assessment.
    (4) Description of the likely respondents, including the estimated 
number of likely respondents, and proposed frequency of response to the 
collection of information: The 2,000 respondents for both disclosures 
are mortgage lenders/servicers. (i) It is estimated that respondents 
must give a one-time disclosure to 34.9 million borrowers who establish 
or maintain mortgage loan escrow accounts. (ii) It is estimated that 
respondents must give a one-time disclosure to 1 million borrowers who 
are identified as having a substantially increased tax charge the 
second year of the loan. (iii) Settlement statements and good faith 
estimates currently provide for inclusion of costs associated for lead-
based paint inspection costs, but not as a discrete line item. The 
number of respondents will not change as a result of this rule.
    (5) Estimate of the total reporting and recordkeeping burden that 
will result from the collection of information: (There is no additional 
burden expected to result from specifying a discrete line for lead-
based paint risk assessment or inspection costs in the settlement 
statements (appendix A) or good faith estimate format (appendix C).)

                                                Reporting Burden                                                
----------------------------------------------------------------------------------------------------------------
                                                                                      Est. ave.                 
               Reference                    Number of respondents       Frequency     response     Annual burden
                                                                       of response   time (hrs.)       hrs.     
----------------------------------------------------------------------------------------------------------------
Disbursement Disclosure...............  34.9 mill....................            1        0.0833       2,908,332
Method C Calculation..................  2,000........................            1       10               20,000
Calculation and Disclosure (Borrower    1.0 mill.....................            1        0.3333         333,000
 Choice).                                                                                                       
----------------------------------------------------------------------------------------------------------------


                          Recordkeeping Burden                          
------------------------------------------------------------------------
                                                                Annual  
              No. recordkeepers                  Hrs. per       burden  
                                               recordkeeper     hours   
------------------------------------------------------------------------
Disbursement Disclosure: 2,000...............         1,454    2,908,000
Calculation Disclosure: 2,000................            42       84,000
                                              --------------------------
      Total Burden Hours.....................  ............    6,253,332
------------------------------------------------------------------------

    (b) In accordance with 5 CFR 1320.8(d)(1), the Department is 
soliciting comments from members of the public and affected agencies 
concerning the proposed collection of information to:
    (1) Evaluate whether the proposed collection of information is 
necessary for the proper performance of the functions of the agency, 
including whether the information will have practical utility;

[[Page 46520]]

    (2) Evaluate the accuracy of the agency's estimate of the burden of 
the proposed collection of information;
    (3) Enhance the quality, utility, and clarity of the information to 
be collected; and
    (4) Minimize the burden of the collection of information on those 
who are to respond; including through the use of appropriate automated 
collection techniques or other forms of information technology, e.g., 
permitting electronic submission of responses.
    Interested persons are invited to submit comments regarding the 
information collection requirements in this proposal. Under the 
provisions of 5 CFR part 1320, OMB is required to make a decision 
concerning this collection of information between 30 and 60 days after 
today's publication date. Therefore, a comment on the information 
collection requirements is best assured of having its full effect if 
OMB receives the comment within 30 days of today's publication. This 
time frame does not affect the deadline for comments to the agency on 
the proposed rule, however. Comments must refer to the proposal by name 
and docket number (FR-4079) and must be sent to:

Joseph F. Lackey, Jr., HUD Desk Officer, Office of Management and 
Budget, New Executive Office Building, Washington, DC 20503
      and
Reports Liaison Officer, Office of the Assistant Secretary for Housing, 
Federal Housing Commissioner, Department of Housing and Urban 
Development, 451--7th Street, SW, Room 9116, Washington, DC 20410

    Status: Extension of currently approved collection (2502-0501).

Executive Order 12866

    The Office of Management and Budget reviewed this proposed rule 
under Executive Order 12866, Regulatory Planning and Review. Any 
changes made to the rule as a result of that review are clearly 
identified in the docket file, which is available for public inspection 
at the Office of the Rules Docket Clerk, Office of General Counsel, 
Room 10276, Department of Housing and Urban Development, 451 Seventh 
Street, SW, Washington, DC 20410-0500.

Regulatory Flexibility Act

    The Secretary, in accordance with the Regulatory Flexibility Act (5 
U.S.C. 605(b)), has reviewed this rule before publication and by 
approving it certifies that this proposed rule does not have a 
significant economic impact on a substantial number of small entities. 
There are no anticompetitive discriminatory aspects of this proposed 
rule with regard to small entities, nor are there any unusual 
procedures that would need to be complied with by small entities. The 
requirements of RESPA must be uniformly adhered to by all lenders and 
servicers. To the extent that small entities are affected by any of the 
provisions in the proposed rule, the impact is expected to be 
relatively insignificant and will be reviewed in developing the final 
rule.
    However, this proposed rule describes possible alternative 
requirements and seeks comments to help the Department make a final 
decision regarding these alternatives. Although a complete and thorough 
analysis of all the possible permutations in the rule is impractical, 
the proposed rule provides sufficient information for the public to 
provide the Department with informed comments and, to the extent 
feasible, otherwise addresses areas that would be included in a 
regulatory flexibility analysis.

Environmental Impact

    A Finding of No Significant Impact with respect to the environment 
has been made in accordance with HUD regulations in 24 CFR part 50 that 
implement section 102(2)(C) of the National Environmental Policy Act of 
1969 (42 U.S.C. 4332). The finding is available for public inspection 
during regular business hours in the Office of the General Counsel, 
Rules Docket Clerk, room 10276, 451 Seventh Street, SW, Washington, DC 
20410.

Executive Order 12612, Federalism

    The General Counsel, as the Designated Official under section 6(a) 
of Executive Order 12612, Federalism, has determined that the policies 
contained in this proposed rule will not have substantial direct 
effects on States or their political subdivisions, or the relationship 
between the Federal Government and the States, or on the distribution 
of power and responsibilities among the various levels of government. 
As a result, the rule is not subject to review under the Order. 
Promulgation of this rule expands coverage of the applicable regulatory 
requirements pursuant to statutory direction.

Executive Order 12606, The Family

    The General Counsel, as the Designated Official under Executive 
Order 12606, The Family, has determined that this proposed rule does 
not have potential for significant impact on family formation, 
maintenance, and general well-being, and, thus, is not subject to 
review under the order. No significant change in existing HUD policies 
or programs will result from promulgation of this rule, as those 
policies and programs relate to family concerns.

List of Subjects in 24 CFR Part 3500

    Consumer protection, Condominiums, Housing, Mortgages, Mortgage 
servicing, Reporting and Recordkeeping requirements.

    For the reasons stated in the preamble, part 3500 of Title 24 of 
the Code of Federal Regulations is proposed to be amended as follows.

PART 3500--REAL ESTATE SETTLEMENT PROCEDURES ACT

    1. The authority citation for part 3500 continues to read as 
follows:

    Authority: 12 U.S.C. 2601 et seq.; 42 U.S.C. 3535(d).

    2. Appendix A is amended in Section L under the text heading ``Line 
Item Instructions'' as follows:
    a. By revising the paragraph beginning with the phrase ``Lines 1301 
and 1302'';
    b. In the paragraph beginning with the phrase ``Lines 1303-1305'', 
by removing the number ``1303'' and adding in its place the number 
``1304''; and
    c. By adding a new paragraph after the paragraph beginning with the 
phrase ``Lines 1301 and 1302'', to read as follows:

Appendix A to Part 3500--Instructions for Completing HUD-1 and HUD-1A 
Settlement Statements; Sample HUD-1 and HUD-1A Statements

* * * * *
    Lines 1301 and 1302 are used for fees for survey, pest 
inspection, radon inspection, or other similar inspections.
    Line 1303 is used for lead-based paint hazard risk assessments, 
lead-based paint inspections, or other lead-based paint evaluations.
* * * * *
    3. Appendix C, Sample Form of Good Faith Estimate, is amended in 
the chart by adding a new row, with three columns, after the row with 
the phrase ``Pest inspection......'' in the first column, to read as 
follows:

Appendix C to Part 3500--Sample Form of Good Faith Estimate

* * * * *

[[Page 46521]]



------------------------------------------------------------------------
             Item \2\                HUD-1 or HUD-1A    Amount or range 
------------------------------------------------------------------------
                                                                        
*                  *                  *                  *              
                 *                    *                  *              
Lead-based paint inspection.......               1303                  $
                                                                        
*                  *                  *                  *              
                  *                  *                  *               
------------------------------------------------------------------------
\2\ Footnote remains unchanged.                                         

Annual Vs. Installment Disbursements [Items 4-5]

    4. Section 3500.17 is amended by revising the definition of 
``disbursement date'' in paragraph (b) and by revising paragraphs 
(c)(2) and (3), to read as follows:


Sec.  3500.17  Escrow accounts.

* * * * *
    (b) * * *
    Disbursement date means the date on which the servicer actually 
pays an escrow item from the escrow account.
* * * * *
    (c) * * *
    (2) Escrow analysis at creation of escrow account. Before 
establishing an escrow account, the servicer shall conduct an escrow 
account analysis to determine the amount the borrower shall deposit 
into the escrow account, subject to the limitations of paragraph 
(c)(1)(i) of this section and the amount of the borrower's periodic 
payments into the escrow account, subject to the limitations of 
paragraph (c)(1)(ii) of this section. In conducting the escrow account 
analysis, the servicer shall estimate the disbursement amounts 
according to paragraph (c)(7) of this section. Pursuant to paragraph 
(k) of this section, the servicer shall use a date on or before the 
deadline to avoid a penalty as the disbursement date for the escrow 
item. Upon completing the initial escrow account analysis, the servicer 
shall prepare and deliver an initial escrow account statement to the 
borrower, as set forth in paragraph (g) of this section. The servicer 
shall use the escrow account analysis to determine whether a surplus, 
shortage, or deficiency exists since settlement and shall make any 
adjustments to the account pursuant to paragraph (f) of this section.
    (3) Subsequent escrow account analyses. For each escrow account, 
the servicer shall conduct an escrow account analysis at the completion 
of the escrow account computation year to determine the borrower's 
monthly escrow account payments for the next computation year, subject 
to the limitations of paragraph (c)(1)(ii) of this section. In 
conducting the escrow account analysis, the servicer shall estimate the 
disbursement amounts according to paragraph (c)(7) of this section. 
Pursuant to paragraph (k) of this section, the servicer shall use a 
date on or before the deadline to avoid a penalty as the disbursement 
date for the escrow item. The servicer shall use the escrow account 
analysis to determine whether a surplus, shortage, or deficiency exists 
and shall make any adjustments to the account pursuant to paragraph (f) 
of this section. Upon completing an escrow account analysis, the 
servicer shall prepare and submit an annual escrow account statement to 
the borrower, as set forth in paragraph (i) of this section.
* * * * *
    5. Section 3500.17 is further amended and, if applicable, Appendix 
F is added to part 3500 in accordance with one of the following 
alternatives:
    a. Under ALTERNATIVE 1 (Consumer Choice): By revising paragraph (k) 
and adding Appendix F to part 3500, to read as follows; or
    b. Under ALTERNATIVE 2 (Servicer Flexibility): By revising 
paragraph (k), to read as follows; or
    c. Under ALTERNATIVE 3 (Keep, But Clarify, Current Requirements): 
By revising paragraph (k), to read as follows:


Sec.  3500.17  Escrow accounts.

* * * * *
[Alternative 1 (Consumer Choice)]
    (k) Timely payments. (1) If the terms of any federally related 
mortgage loan require the borrower to make payments to an escrow 
account, the servicer shall pay the disbursements in a timely manner, 
that is, on or before the deadline to avoid a penalty, as long as the 
borrower's payment is not more than 30 days overdue.
    (2) The servicer shall advance funds to make disbursements in a 
timely manner, as long as the borrower's payment is not more than 30 
days overdue. Upon advancing funds to pay a disbursement, the servicer 
may seek repayment from the borrower for the deficiency pursuant to 
paragraph (f) of this section.
    (3) For those borrowers whose property taxes will be paid from an 
escrow account where the applicable taxing jurisdiction offers the 
choice between disbursements on an installment or an annual basis, at 
some time before closing the servicer shall provide to the borrower an 
Escrow Account Property Tax Disbursement Alternatives Selection sheet 
in the format of Appendix F to this part and shall provide the borrower 
with an opportunity to make a selection.
    (4) For a loan that settles on or after [INSERT EFFECTIVE DATE OF 
FINAL RULE], when the taxing jurisdiction offers the servicer the 
option of making disbursements for property taxes on an installment or 
an annual basis, the servicer must make disbursements for property 
taxes on an installment basis, unless the borrower has indicated on the 
Escrow Account Property Tax Disbursement Alternatives Selection sheet 
that disbursements for property taxes are to be made on an annual 
basis. The servicer and subsequent servicers are prohibited from 
changing the method of disbursement for property taxes from the method 
the borrower selected on the Escrow Account Property Tax Disbursement 
Alternatives Selection sheet, without the borrower's prior written 
consent.
    (5) For a loan that has settled prior to [INSERT EFFECTIVE DATE OF 
FINAL RULE], when the taxing jurisdiction offers the servicer the 
option of making disbursements for property taxes on an installment or 
an annual basis, the servicer and subsequent servicers are prohibited 
from changing the method of disbursement for property taxes from the 
method that was used on [INSERT DATE OF PUBLICATION OF FINAL RULE] or 
the date of settlement (whichever is later), without the borrower's 
prior written consent, as long as such method of disbursement complies 
with normal lending practice of the lender and local custom and 
constitutes prudent lending practice. In addition, no later than the 
first escrow account analysis performed after [INSERT EFFECTIVE DATE OF 
FINAL RULE], a servicer shall offer a borrower, in writing, the 
opportunity to switch from one disbursement method for property taxes 
to the other.
    (6) If the payee for escrow items other than property taxes offers 
the servicer

[[Page 46522]]

the option of making disbursements on an installment or an annual 
basis, the servicer must make disbursements by a date that avoids a 
penalty, but may otherwise make disbursements on either an installment 
or an annual basis as the servicer prefers, as long as such method of 
disbursement complies with normal lending practice of the lender and 
local custom and constitutes prudent lending practice.
* * * * *

Appendix F--Escrow Account Property Tax Disbursement Alternatives 
Selection Format

    Your property taxes will be disbursed out of your escrow account 
by your loan servicer. Your jurisdiction provides the option of 
paying the property taxes in installment payments spread out over 
the year, or in one annual lump sum payment.
    You are being offered alternative methods for these property 
taxes to be paid. They are described below.
    As shown by the choices below, if you choose installment 
payments, the amount you have to deposit into your escrow account at 
closing may be less. On the other hand, if you choose annual 
payments, the total amount of property taxes you will pay may be 
less if your taxing jurisdiction provides a discount for annual 
payments. The alternative you choose could also affect the amount of 
your tax deductions during the first year of the loan, if you 
itemize--you may wish to consult a tax advisor.
    If you do not make a selection, disbursements will be made on an 
installment basis.

          Escrow Account Property Tax Disbursement Alternatives         
------------------------------------------------------------------------
                                        Installment                     
                                          payments       Annual payments
------------------------------------------------------------------------
Property tax bill for next 12        ________.........  ________        
 months.                                                                
Due at closing.....................  ________.........  ________        
Monthly escrow payment first year..  ________.........  ________        
------------------------------------------------------------------------

I prefer the indicated option (check one and sign below)
    {time}  Installment Payments
    {time}  Annual Payments

----------------------------------------------------------------------
Borrower's Signature
[Or Alternative 2 (Servicer Flexibility)]
    (k) Timely payments. (1) If the terms of any federally related 
mortgage loan require the borrower to make payments to an escrow 
account, the servicer shall pay the disbursements in a timely manner, 
that is, on or before the deadline to avoid a penalty, as long as the 
borrower's payment is not more than 30 days overdue.
    (2) The servicer shall advance funds to make disbursements in a 
timely manner as long as the borrower's payment is not more than 30 
days overdue. Upon advancing funds to pay a disbursement, the servicer 
may seek repayment from the borrower for the deficiency, pursuant to 
paragraph (f) of this section.
    (3) If the payee for escrow items (including property taxes) offers 
the servicer the option of making disbursements on an installment basis 
or a lump sum annual basis, the servicer must make disbursements by a 
date that avoids a penalty, but may otherwise make disbursements on 
either an installment basis or a lump sum annual basis as the servicer 
prefers, as long as such method of disbursement complies with normal 
lending practice of the lender and local custom and constitutes prudent 
lending practice.
    (4) The servicer and subsequent servicers are prohibited from 
changing the method of disbursement as long as a choice continues to 
exist, without the borrower's prior written consent.
* * * * *
[Or Alternative 3 (Keep, But Clarify, Current Requirements)]
    (k) Timely payments. (1) If the terms of any federally related 
mortgage loan require the borrower to make payments to an escrow 
account, the servicer shall pay the disbursements in a timely manner, 
that is, on or before the deadline to avoid a penalty, as long as the 
borrower's payment is not more than 30 days overdue.
    (2) The servicer shall advance funds to make disbursements in a 
timely manner as long as the borrower's payment is not more than 30 
days overdue. Upon advancing funds to pay a disbursement, the servicer 
may seek repayment from the borrower for the deficiency pursuant to 
paragraph (f) of this section.
    (3) If the payee for escrow items (including property taxes) offers 
the servicer the option of making disbursements on an installment or a 
lump sum annual basis, the servicer shall make disbursements by a date 
that avoids a penalty. If such payee does not offer a discount for 
disbursements on a lump sum annual basis, the servicer must make 
disbursements on an installment basis. If, however, the payee offers a 
discount for disbursements on a lump sum annual basis, the servicer 
may, at the servicer's discretion (but is not required by RESPA to), 
make lump sum annual disbursements in order to take advantage of the 
discount for the borrower, as long as such method of disbursement 
selected by the servicer complies with normal lending practice of the 
lender and local custom and constitutes prudent lending practice. Where 
the payee offers the option of installment disbursements or a discount 
for lump sum annual disbursements, HUD encourages, but does not 
require, the servicer to follow the preference of the borrower as to 
whether to make disbursements on a lump sum annual or installment 
basis, if such preference is known to the servicer.
    (4) The servicer and subsequent servicers for an escrow account are 
prohibited from changing the method of disbursement as long as a choice 
of disbursement methods exists, without the borrower's prior written 
consent.
* * * * *

Payment Shock [Item 6]

    6. Except with respect to Alternative 2 in this amendatory 
instruction, Sec. 3500.17 is further amended and, if applicable, 
appendices are added to part 3500, in accordance with either 
Alternative 1 or Alternative 3, as follows:
    a. Under ALTERNATIVE 1 (Consumer Choice): By adding, in 
alphabetical order, a definition of ``Substantial increase''; by 
revising the introductory text of paragraph (c); by revising paragraph 
(d); by adding new paragraphs to be designated later; and by adding 
Appendices G and H-1, to read as follows; or
    b. ALTERNATIVE 2 (Make No Change); or
    c. Under ALTERNATIVE 3 (Mandate First Year Overpayment): By adding, 
in alphabetical order, in paragraph (b), a definition of ``Substantial 
increase''; by revising the introductory text of paragraph (c); by 
revising paragraph (d); by adding new paragraphs, to be designated 
later; and by adding Appendix H-2, to read as follows:


Sec. 3500.17   Escrow accounts.

* * * * *
Alternative 1 (Consumer Choice)
    (b) * * *
    Substantial increase means an increase of 50 percent or more in the 
monthly escrow payment in the second year of an escrow account is 
projected as compared to the payment under the initial escrow 
accounting.
* * * * *
    (c) Limits on payments to escrow accounts; acceptable accounting 
methods to determine limits. Except as otherwise provided in paragraph 
(__) of this section, the following applies:
 * * * * *
    (d) Methods of escrow account analysis. Paragraph (c) of this 
section

[[Page 46523]]

prescribes acceptable accounting methods except as otherwise provided 
in paragraph (__) of this section. The following sets forth the steps 
servicers shall use to determine whether their use of an acceptable 
accounting method conforms with the limitations in paragraph (c)(1) of 
this section. The steps set forth in this section derive maximum 
limits. Servicers may use accounting procedures that result in lower 
target balances. In particular, servicers may use a cushion less than 
the permissible cushion or no cushion at all. This section does not 
require the use of a cushion.
* * * * *
    (__) Rules of special applicability when servicer expects a 
substantial increase in bills paid out of escrow account after the 
first year for loans that settle on or after [INSERT EFFECTIVE DATE OF 
FINAL RULE].
    (X) Opportunity for Selection of Escrow Account Method. When a 
servicer expects that there will be a substantial increase in the bills 
paid out of an escrow account after the first year, at some time before 
closing, the servicer shall provide to the borrower an Escrow 
Accounting Method Selection sheet in the format of Appendix G to this 
part and shall provide the borrower with an opportunity to make a 
selection. The servicer must perform the escrow accounting in 
accordance with the method selected by the borrower. If the borrower 
does not make a selection, the servicer must perform the escrow 
accounting in accordance with Method A.
    (XX) No Change in Escrow Accounting Method without Borrower 
Consent. (1) Once an escrow accounting method is determined by the 
process in paragraph (X) of this section, the servicer and subsequent 
servicers are prohibited from changing the escrow accounting method 
unless either paragraph (__)(XX) (i) or (ii) applies:
    (i) The borrower provides his or her prior written consent; or
    (ii) The servicer no longer projects that there will be a 
substantial increase in bills paid out of the escrow account after the 
12-month period covered in the projection for the coming year.
    (2) If the servicer changes escrow account methods in reliance on 
paragraph (__)(XX)(ii) of this section, the servicer may switch only to 
the escrow accounting procedure in paragraph (d) of this section.
    (XXX) Limits on payments to escrow accounts; acceptable accounting 
methods to determine limits when servicer expects substantial increase 
in bills paid out of escrow account after the first year for loans 
which settle on or after [INSERT EFFECTIVE DATE OF RULE]. When the 
servicer expects a substantial increase in bills paid out of the escrow 
account after the first year, the servicer may deviate from the 
requirements of paragraph (c) of this section to the extent necessary 
to comply with paragraph (XXXX) of this section.
    (XXXX) Methods of escrow account analysis for the initial statement 
when the servicer expects a substantial increase in bills paid out of 
the escrow account after the first year. When the servicer expects a 
substantial increase in the bills paid out of the escrow account after 
the first year, the servicer shall use the following steps in producing 
the projection for the initial statement:
    (1) Method A. When a servicer uses Method A in conducting the 
initial escrow account analysis, paragraph (d) of this section applies.
    (2) Method B. When a servicer uses Method B in conducting the 
initial escrow account analysis, the target balances may not exceed the 
balances computed according to the following arithmetic operations: The 
servicer projects a trial balance for the account as a whole over the 
next computation year (a trial running balance) with a beginning 
balance of 0. The servicer may include as disbursements only those 
amounts that are expected to be paid in the 12-month period covered by 
the projection. In doing so, the servicer assumes that it will make 
estimated disbursements on or before the deadline to avoid a penalty. 
The servicer does not use pre-accrual on the disbursement dates. The 
servicer also assumes that the borrower will make monthly payments 
equal to one-twelfth of the estimated total annual escrow account 
disbursements for the second year.
    (3) Method C. When a servicer uses Method C in conducting the 
initial escrow account analysis, the target balances may not exceed the 
balances computed according to the following arithmetic operations:
    (i) The servicer first projects a trial balance for the account as 
a whole over the next computation year (a trial running balance). The 
servicer may include as disbursements only those amounts that are 
expected to be paid in the 12-month period covered by the projection. 
In doing so, the servicer assumes that it will make estimated 
disbursements on or before the deadline to avoid a penalty. The 
servicer does not use pre-accrual on these disbursement dates. The 
servicer also assumes that the borrower will make monthly payments 
equal to one-twelfth of the estimated total annual escrow account 
disbursements for the second year.
    (ii) The servicer then examines the monthly trial balances and adds 
to the initial deposit an amount just sufficient to bring the lowest 
monthly trial balance (not considering the initial deposit) to zero, 
and adjusts all other monthly balances and the initial deposit 
accordingly.
    (iii) The servicer then adds to the initial deposit the permissible 
cushion. The cushion is one-sixth of the estimated total annual escrow 
account disbursements for the second year or a lesser amount specified 
by State law or the mortgage document.
    (4) The steps set forth in this paragraph (XXXX) derive maximum 
limits. Servicers may use accounting procedures that result in lower 
target balances. In particular, servicers may use a cushion less than 
the permissible cushion or no cushion at all. This paragraph (XXXX) 
does not require the use of a cushion.
* * * * *

Appendix G--Sample Escrow Accounting Method Selection Format

    The bills paid out of your escrow account are expected to 
increase substantially after the first year. Under normal escrow 
practices, your monthly escrow payment in the second year could be 
much higher than in the first, both to pay the larger bills and to 
make up for a shortage at the end of the first year. (See Method A.) 
You may voluntarily choose to make higher payments during the first 
year to reduce or eliminate the monthly payment increase in the 
second year. (See Methods B or C.) You are being offered alternative 
escrow payment schedules. They are described below. If you do not 
make a selection, Method A will be used.

                                           Escrow Account Alternatives                                          
----------------------------------------------------------------------------------------------------------------
                                                Method A                 Method B                Method C       
----------------------------------------------------------------------------------------------------------------
Due at closing........................  __________.............  __________.............  __________            
Monthly escrow payment first year.....  __________.............  __________.............  __________            
Estimated surplus refunded at end of    __________.............  __________.............  __________            
 first year.                                                                                                    
Estimated monthly escrow payment        __________.............  __________.............  __________            
 second year.                                                                                                   

[[Page 46524]]

                                                                                                                
Estimated monthly escrow payment third  __________.............  __________.............  __________            
 year.                                                                                                          
----------------------------------------------------------------------------------------------------------------

I prefer the indicated method (check one and sign below)
    A {time} 
    B {time} 
    C {time} 

----------------------------------------------------------------------
Borrower's Signature

Appendix H-1--The Payment Shock Problem

Instructions and Sample Mathematical Calculations for Completing Escrow 
Accounting Method Selection Format

Assumptions

Disbursements

Year 1

$720 for insurance--disbursed in April
$288 for property taxes--disbursed in November

Year 2

$720 for insurance--disbursed in April
$2,880 for property taxes--disbursed in November

First Payment: June 15

Method A

[Demonstrates calculation for completing Method A of Escrow 
Accounting Method Selection Format (Appendix G).]

    Assumption: Cushion selected by servicer equals one-sixth of 
estimated total annual disbursements.

Step 1.--Projection for Year 1

    See 24 CFR 3500.17(k) for instructions and Appendix E to Part 
3500 for sample calculation (example below uses aggregate analysis).

------------------------------------------------------------------------
                    Year 1                     Payment  Disburs  Balance
------------------------------------------------------------------------
Initial deposit:                                                     252
  Jun........................................       84        0      336
  Jul........................................       84        0      420
  Aug........................................       84        0      504
  Sep........................................       84        0      588
  Oct........................................       84        0      672
  Nov........................................       84      288      468
  Dec........................................       84        0      552
  Jan........................................       84        0      636
  Feb........................................       84        0      720
  Mar........................................       84        0      804
  Apr........................................       84      720      168
  May........................................       84        0      252
------------------------------------------------------------------------

Step 2.--Projection for Year 2

------------------------------------------------------------------------
                    Year 2                     Payment  Disburs  Balance
------------------------------------------------------------------------
Starting balance:                                                   1680
  Jun........................................      300        0     1980
  Jul........................................      300        0     2280
  Aug........................................      300        0     2580
  Sep........................................      300        0     2880
  Oct........................................      300        0     3180
  Nov........................................      300     2880      600
  Dec........................................      300        0      900
  Jan........................................      300        0     1200
  Feb........................................      300        0     1500
  Mar........................................      300        0     1800
  Apr........................................      300      720     1380
  May........................................      300        0     1680
------------------------------------------------------------------------

Shortage (or surplus) = Desired starting balance--Actual starting 
balance
    = 1680-252
    = 1428
Additional Monthly Escrow Payment = Shortage/12
    = 1428/12
    = 119
Monthly escrow payment = Shortage/12 + Disbursements/12 
    = 119 + 300
    = 419

Step 3.--Projection for Year 3

    Same as year 2. Since there is no shortage or surplus, the 
monthly payment is $300 per month.

Method A Summary To Appear on Disclosure

Due at closing = $252
Monthly escrow payment first year = $84/month
Estimated surplus refunded at end of first year = $0
Estimated monthly escrow payment second year = $419
Estimated monthly escrow payment third year = $300

Method B

[Demonstrates calculation for completing Method B of Escrow 
Accounting Method Selection Format (Appendix G).]

    Assumption: On the initial statement, the initial deposit equals 
$0 and the monthly deposit equals \1/12\ of second year's estimated 
total annual disbursements. Any subsequent analysis uses the escrow 
accounting technique in 24 CFR 3500.17(c)(3).

Step 1.--Projection for Year 1

------------------------------------------------------------------------
                    Year 1                     Payment  Disburs  Balance
------------------------------------------------------------------------
Initial deposit:                                                       0
  Jun........................................      300        0      300
  Jul........................................      300        0      600
  Aug........................................      300        0      900
  Sep........................................      300        0     1200
  Oct........................................      300        0     1500
  Nov........................................      300      288     1512
  Dec........................................      300        0     1812
  Jan........................................      300        0     2112
  Feb........................................      300        0     2412
  Mar........................................      300        0     2712
  Apr........................................      300      720     2292
  May........................................      300        0     2592
------------------------------------------------------------------------

Step 2.--Projection for Year 2

    Projection same as for Method A.

Shortage/Surplus = Desired starting balance - Actual balance
    = 1680-2592
    = -912 (912 surplus)
    This $912 surplus is refunded to borrower at end of Year 1. 
Thus, the borrower starts Year 2 with the desired starting balance 
of 1680 and the monthly payment is $300.

Step 3.--Projection for Year 3

    Same as year 2. Since there is no shortage or surplus, the 
monthly payment is $300 per month.

Method B Summary To Appear on Disclosure

    Due at closing = $0
    Monthly escrow payment first year = $300/month
    Estimated surplus refunded at end of first year = $912
    Estimated monthly escrow payment second year = $300
    Estimated monthly escrow payment third year = $300

Method C

[Demonstrates calculation for completing Method C of Escrow 
Accounting Method Selection Format (Appendix G).]

    Assumption: On the initial statement, the cushion selected by 
servicer equals \1/6\ of estimated total annual disbursements for 
the second year and the Monthly deposit equals \1/12\ of estimated 
total annual disbursements for the second year. Any subsequent 
analysis uses the escrow accounting technique in 24 CFR 
3500.17(c)(3).

Step 1.--Projection for Year 1

------------------------------------------------------------------------
                    Year 1                     Payment  Disburs  Balance
------------------------------------------------------------------------
Initial deposit:                                                     300
  Jan........................................      300        0      600
  Feb........................................      300        0      900
  Mar........................................      300        0     1200
  Apr........................................      300        0     1500
  May........................................      300        0     1800
  Jun........................................      300      288     1812
  Jul........................................      300        0     2112
  Aug........................................      300        0     2412
  Sep........................................      300        0     2712
  Oct........................................      300        0     3012
  Nov........................................      300      720     2592
  Dec........................................      300        0     2892
------------------------------------------------------------------------


[[Page 46525]]



Step 2.--Projection for Year 2

    Projection same as for methods A and B.

Shortage/Surplus = Desired starting balance - Actual balance
    = 1680-2892
    = -1212 (1212 surplus)

    This $1212 surplus is refunded to borrower at end of Year 1. 
Thus, the borrower starts Year 2 with the desired starting balance 
of $1680 and the monthly payment is $300.

Step 3.--Projection for Year 3

    Same as year 2. Since there is no shortage or surplus, the 
monthly payment is $300 per month.

Method C Summary To Appear on Disclosure

Due at closing = $300
Monthly escrow payment first year = $300/month
Estimated surplus refunded at end of first year = $1212
Estimated monthly escrow payment second year = $300
Estimated monthly escrow payment third year = $300

Comparative Illustrations

    1. The escrow account methods for the example shown in the text, 
with insurance disbursed in the eleventh month and taxes disbursed 
in the sixth month of the escrow cycle, are shown below:

------------------------------------------------------------------------
                                                        Methods         
                                              --------------------------
                                                  A        B        C   
------------------------------------------------------------------------
Due at closing...............................      252        0      300
Monthly escrow payment first year............       84      300      300
Estimated surplus refunded at end of first                              
 year........................................        0      912     1212
Estimated monthly escrow payment second year.      419      300      300
Estimated monthly escrow payment third year..      300      300      300
------------------------------------------------------------------------

    2. The following set of options shows the resulting values if, 
as before, insurance were disbursed in the eleventh month of the 
escrow cycle, but taxes were disbursed in the first rather than the 
sixth month of the escrow cycle. Note how payments change as the 
month in which the taxes are disbursed changes and all other factors 
remain constant.

------------------------------------------------------------------------
                                                        Methods         
                                              --------------------------
                                                  A        B        C   
------------------------------------------------------------------------
Due at closing...............................      372        0      588
Monthly escrow payment first year............       84      300      300
Estimated surplus refunded at end of first                              
 year........................................        0        0        0
Estimated monthly escrow payment second year.      534      349      300
Estimated monthly escrow payment third year..      300      300      300
------------------------------------------------------------------------

    3. The final set of options shows the resulting values if, as 
before, insurance were disbursed in the eleventh month of the escrow 
cycle, but taxes were disbursed in the last month of the escrow 
cycle.

------------------------------------------------------------------------
                                                        Methods         
                                              --------------------------
                                                  A        B        C   
------------------------------------------------------------------------
Due at closing...............................      168        0      300
Monthly escrow payment first year............       84      300      300
Estimated surplus refunded at end of first                              
 year........................................        0     1992     2292
Estimated monthly escrow payment second year.      336      300      300
Estimated monthly escrow payment third year..      330      300      300
------------------------------------------------------------------------

[or Alternative 3 (Mandate First Year Overpayment)]
    (b) * * *
    Substantial increase means an increase of 50 percent or more in the 
monthly escrow payment in the second year of an escrow account is 
projected as compared to the payment under the initial escrow 
accounting.
* * * * *
    (c) Limits on payments to escrow accounts; acceptable accounting 
methods to determine limits. Except as provided in paragraph (__) of 
this section, the following applies:
* * * * *
    (d) Methods of escrow account analysis. Paragraph (c) of this 
section prescribes acceptable accounting methods except as otherwise 
provided in paragraph (__) of this section. The following sets forth 
the steps servicers shall use to determine whether their use of an 
acceptable accounting method conforms with the limitations in paragraph 
(c)(1) of this section. The steps set forth in this section derive 
maximum limits. Servicers may use accounting procedures that result in 
lower target balances. In particular, servicers may use a cushion less 
than the permissible cushion or no cushion at all. This section does 
not require the use of a cushion.
* * * * *
    (__) Rules of special applicability where servicer expects 
substantial increase in bills paid out of escrow account after the 
first year for loans which settle on or after [INSERT EFFECTIVE DATE OF 
FINAL RULE].
    (X) Limits on payments to escrow accounts; acceptable accounting 
methods to determine limits when servicer expects substantial increase 
in bills paid out of escrow account after the first year for loans 
which settle on or after [INSERT EFFECTIVE DATE OF FINAL RULE]. When 
the servicer expects a substantial increase in bills paid out of escrow 
account after the first year, the servicer may deviate from the 
requirements of paragraph (c) of this section to the extent necessary 
to comply with paragraph (XX) of this section.
    (XX) Methods of escrow account analysis for the initial statement 
when the servicer expects a substantial increase in the bills paid out 
of the escrow account after the first year. When the servicer expects a 
substantial increase in the bills paid out of the escrow account after 
the first year, the servicer shall use the following steps in producing 
the projection for the initial statement:
    (1) When a servicer uses this method of escrow accounting in 
conducting the initial escrow account analysis, the target balances may 
not exceed the balances computed according to the following arithmetic 
operations:
    (i) The servicer first projects a trial balance for the account as 
a whole over the next computation year (a trial running balance). The 
servicer may include as disbursements only those amounts that are 
expected to be paid in the 12-month period covered by the projection. 
In doing so, the servicer assumes that it will make estimated 
disbursements on or before the deadline to avoid a penalty. The 
servicer does not use pre-accrual on these disbursement dates. The 
servicer also assumes that the borrower will make monthly payments 
equal to one-twelfth of the estimated total annual escrow account 
disbursements for the second year.
    (ii) The servicer then examines the monthly trial balances and adds 
to the initial deposit an amount just sufficient to bring the lowest 
monthly trial balance (not considering the initial deposit) to zero, 
and adjusts all other monthly

[[Page 46526]]

balances and the initial deposit accordingly.
    (iii) The servicer then adds to the initial deposit the permissible 
cushion. The cushion is one-sixth of the estimated total annual escrow 
account disbursements for the second year or a lesser amount specified 
by State law or the mortgage document.
    (2) The steps set forth in this paragraph (XX) derive maximum 
limits. Servicers may use accounting procedures that result in lower 
target balances. In particular, servicers may use a cushion less than 
the permissible cushion or no cushion at all. This paragraph (XX) does 
not require the use of a cushion.
* * * * *

Appendix H-2

The Payment Shock Problem

Instructions and Sample Mathematical Calculations for Alternative 
Escrow Accounting Method

Assumptions

Disbursements:

Year 1

$720 for insurance--disbursed in April
$288 for property taxes--disbursed in November

Year 2

$720 for insurance--disbursed in April
$2,880 for property taxes--disbursed in November

First Payment: June 15

    Assumption: On the initial statement, the cushion selected by 
servicer equals \1/6\ of estimated total annual disbursements for 
the second year and the Monthly deposit equals \1/12\ of estimated 
total annual disbursements for the second year. Any subsequent 
analysis uses the escrow accounting technique in 24 CFR 
3500.17(c)(3).

Step 1.--Projection for Year 1

------------------------------------------------------------------------
                    Year 1                     Payment  Disburs  Balance
------------------------------------------------------------------------
Initial deposit                                .......  .......      300
  Jan........................................      300        0      600
  Feb........................................      300        0      900
  Mar........................................      300        0     1200
  Apr........................................      300        0     1500
  May........................................      300        0     1800
  Jun........................................      300      288     1812
  Jul........................................      300        0     2112
  Aug........................................      300        0     2412
  Sep........................................      300        0     2712
  Oct........................................      300        0     3012
  Nov........................................      300      720     2592
  Dec........................................      300        0     2892
------------------------------------------------------------------------

Step 2.--Projection for Year 2

------------------------------------------------------------------------
                    Year 2                     Payment  Disburs  Balance
------------------------------------------------------------------------
Starting balance:                              .......  .......     1680
  Jun........................................      300        0     1980
  Jul........................................      300        0     2280
  Aug........................................      300        0     2580
  Sep........................................      300        0     2880
  Oct........................................      300        0     3180
  Nov........................................      300     2880      600
  Dec........................................      300        0      900
  Jan........................................      300        0     1200
  Feb........................................      300        0     1500
  Mar........................................      300        0     1800
  Apr........................................      300      720     1380
  May........................................      300        0     1680
------------------------------------------------------------------------

Shortage/Surplus = Desired starting balance-Actual balance
    = 1680-2892
    = -1212 (1212 surplus)

    This $1212 surplus is refunded to borrower at end of Year 1. 
Thus, the borrower starts Year 2 with the desired starting balance 
of $1680 and the monthly payment is $300.

Step 3.--Projection for Year 3

    Same as year 2. Since there is no shortage or surplus, the 
monthly payment is $300 per month.

Single-Item Analysis With Aggregate Adjustment Problem [Items 7-9]

    7. Section 3500.7 is amended by revising paragraph (c)(2), to read 
as follows:


Sec. 3500.7  Good Faith Estimate.

* * * * *
    (c) * * *
    (2) The borrower will normally pay or incur at or before 
settlement, based upon common practice in the locality of the mortgaged 
property. Each such estimate must be made in good faith and bear a 
reasonable relationship to the charge a borrower is likely to be 
required to pay at settlement and must be based upon experience in the 
locality of the mortgaged property. Reserves to be deposited with the 
lenders for the 1000 series in the HUD-1 and HUD-1A may be estimated 
using a 1-month single item amount for each item. For each charge for 
which the lender requires a particular settlement service provider to 
be used, the lender shall make its estimate based upon the lender's 
knowledge of the amounts charged by such provider.
    8. Section 3500.8 is amended by revising paragraph (c), to read as 
follows:


Sec. 3500.8  Use of HUD-1 and HUD-1A settlement statements.

* * * * *
    (c) Aggregate Accounting At Settlement. Servicers may choose Option 
1 or Option 2 of this paragraph:
    (1) Option 1. The servicer may choose the method in either 
paragraph (c)(1)(i) or (ii) of this section:
    (i) After computing individual deposits in the 1000 series using 
single-item accounting, the servicer shall make an adjustment based on 
aggregate accounting. This adjustment equals the difference in the 
deposit required under aggregate accounting and the sum of the deposits 
required under single-item accounting, with both sets of calculations 
using the same cushion. The computation steps for both accounting 
methods are set out in Sec. 3500.17(d). The adjustment will always be a 
negative number or zero (-0-). The settlement agent shall enter the 
aggregate adjustment amount on a line at the end of the 1000 series of 
the HUD-1 or HUD-1A statement.
    (ii) The settlement agent may initially calculate the 1000-series 
deposits for the HUD-1 and HUD-1A settlement statement using single-
item analysis with a maximum 1-month cushion (unless the mortgage loan 
documents indicate a smaller amount). In the escrow account analysis 
conducted within 45 days of settlement, however, the servicer shall 
adjust the escrow account to reflect the aggregate accounting balance. 
Appendix A to this part contains instructions for completing the HUD-1 
or HUD-1A settlement statements using single item analysis with an 
aggregate adjustment and the alternative process during the phase-in 
period. Appendix E to this part illustrates the arithmetic steps for 
aggregate analysis.
    (2) Option 2. The servicer may complete the aggregate computation, 
as set forth in 24 CFR 3500.17(d), and record the aggregate deposit by 
inserting the words ``Aggregate Escrow Deposit for Items Marked (*) 
Above'' on a line at the end of the 1000 series and placing the total 
on that line. While no individual deposits are to be recorded on the 
other lines of the 1000 series, an asterisk (*) shall be placed next to 
each item in the 1000 series for which a reserve has been collected.
    9. Appendix A is amended in Section L, under the text heading 
``Line Item Instructions,'' by revising in the discussion of ``Lines 
1000-1008'' the second paragraph and the second sentence of the third 
paragraph and by adding a new fourth paragraph, to read as follows:

Appendix A to Part 3500--Instructions for Completing HUD-1 and HUD-1A 
Settlement Statements; Sample HUD-1 and HUD-1A Statements

* * * * *
    Lines 1000-1008. * * *
    The servicer shall pick Option 1 or Option 2. Option 1. After 
itemizing individual deposits in the 1000 series using single-item

[[Page 46527]]

accounting, the settlement agent shall make an adjustment based on 
an aggregate analysis to reflect the difference between the deposit 
required under aggregate accounting and the sum of the deposits 
required under single-item accounting, with both sets of 
calculations using the same cushion. The computation steps for both 
accounting methods are set out in 24 CFR 3500.17(d). The adjustment 
will always be either a negative number or zero (-0-). The servicer 
shall enter the aggregate adjustment amount on a final line in the 
1000 series of the HUD-1 or HUD-1A statement.
    * * * If a servicer has not yet conducted the escrow account 
analysis to determine the aggregate accounting starting balance, the 
settlement agent may initially calculate the 1000 series deposits 
for the HUD-1 and HUD-1A settlement statement using single-item 
analysis with a maximum 1-month cushion (unless the mortgage loan 
documents indicate a smaller amount). * * *
    Option 2. The servicer may complete the aggregate computation, 
as set forth in 24 CFR 3500.17(d), and record the aggregate deposit 
by inserting the words ``Aggregate Escrow Deposit for Items Marked 
(*) Above'' on a line at the end of the 1000 series and placing the 
total on that line. While no individual deposits are to be recorded 
on the other lines of the 1000 series, an asterisk (*) shall be 
placed next to each item in the 1000 series for which a reserve has 
been collected.
* * * * *
    Dated: July 5, 1996.
Nicolas P. Retsinas,
Assistant Secretary for Housing--Federal Housing Commissioner.
[FR Doc. 96-22371 Filed 8-30-96; 8:45 am]
BILLING CODE 4210-27-P