Handling Escrow on Your Loans – 3 of 3

Special Situations

Check out part 1 – The Rules for Lenders and part 2 – How to do Escrow in Moneylender

Now that we know how to determine the periodic escrow amount and what the allowed amounts are, let’s talk about some situations that commonly come up over the life of a loan in the real world.

Pre-Funding the Escrow Account on a New Loan

Loans are originated at all times of the year, and property taxes and insurance premiums can be due at various times of the year, too.  Sometimes the loan is opened and the property taxes are due almost immediately.  When this happens, it is common and appropriate to require a deposit to the escrow account as part of the loan closing.  Although a lawyer or escrow company will usually figure out the numbers, you can easily determine a reasonable deposit amount yourself.

Taking the amount to be paid in the future as the “expense”, the deposit amount is the expense minus 1/12^th of the expense for each month from when the loan closes to the month when the expense will be paid.  You can add up to 1/6^th of the expense to this number so there will be a little money left in the escrow account in the month when the expense is paid.  If the expense is $120, to be paid in three months, the deposit would be $120 – ($120/12 * 3 months) = $90.  It could be as much as $110 to leave $20 in the account after the expense is paid.  If there are multiple expenses in different months, do the math separately for each expense and add the resulting deposits together.

To record the escrow deposit in Moneylender, enter a payment for the deposit amount on the loan origination date and set the Payment Type to Escrow Only.

Refunding the Escrow Balance at Closing

When a loan is paid off, the balance in the escrow account will need to be returned to the borrower.  This always takes the form of a disbursement from the escrow account to the borrower in the amount of the entire escrow balance.  In Moneylender, when you close a loan, this disbursement will be created for you automatically as part of the closing process on the step where you address the escrow balance.  You can optionally create the disbursement manually from the escrow account on the Settings tab.

Absorbing the Escrow Balance when Charging off a Bad Loan

Escrow funds are legally protected, and lenders are not allowed to apply money in the escrow account toward the loan balance without the borrower’s express permission.  If the loan has gone bad and you are about to charge it off, send a letter to the borrower for them to sign and return that gives you permission to apply the escrow balance toward the loan.  With written authorization you can then apply the escrow balance toward the loan before writing it off.  Moneylender will give you the option to refund the escrow balance or, with the borrower’s permission apply the balance toward the loan as part of the loan closing wizard.

Adding the Escrow Balance to the Payoff Payment

If a borrower wants to use their Escrow balance as part of their payoff payment, you can do this as long as you have their permission in writing to use the escrow account toward their loan balance.  When closing a loan in Moneylender, you can select the option to apply the escrow balance to the loan (with the borrower’s express permission).  To do it manually, create a disbursement from the escrow account and add a payment for the same amount with the payment type set to Final Payment and put “From Escrow” or similar in the description.

If the borrower overpaid the payoff payment, and a refund will be issued on the loan, you can disburse the escrow to the loan and it will increase the refund amount appropriately so you don’t have to write two separate refund checks (one for the loan and one for the escrow account).

Excess Funds in the Escrow Account

It occasionally happens that property taxes or insurance premiums go down or the timing changes.  This may leave you with a minimum balance above the legally prescribed amount.  If the amount is enough to raise an eyebrow, you should refund the extra funds to the borrower.  Refund the surplus by adding a disbursement from the escrow account to the borrower.

In some cases, you might be over by a couple months’ worth of escrow deposits and you can use Moneylender’s “Suggested for Over-Funded Account” option from the escrow Adjustment Calculator to allow the borrower to slightly underpay the escrow expenses this year.  This means the per-payment escrow amount will be a little lower than it otherwise would be.  If they were $300 over this year, they might only be $200 over next year.  Doing this can help prevent large changes to the borrower’s monthly amount due as the escrow swings up and down.

Some lenders send a letter to the borrower showing the amount of the surplus and asking if they want a refund check or to apply the excess to the principal on their loan.  The borrower signs and returns the letter indicating their choice.  This gives them the option and also gives you written authorization to apply funds toward the loan if they choose that option. 

Negative Escrow Account Balances

Sometimes the lender pays an escrow expense and the amount available in the escrow account on a loan is insufficient to cover the expense.  If the borrower doesn’t pay the tax bill on time and the lender pays it for them, this could mean starting an escrow account on a loan with a negative balance, for example.  Sudden increases in property taxes or insurance premiums can also overdraw the borrower’s escrow account.  When this happens, you have two options.

Have the borrower submit a one-time escrow deposit to bring the escrow balance to where it should be.  Moneylender’s Adjustment Calculator will recommend the deposit amount and the new per-payment charge after the deposit in situations where this happens.  The borrower is then expected to send an extra escrow-only payment to cover the shortage.  Another option is to prorate that deposit amount of the next year.  Moneylender’s escrow Adjustment Calculator will suggest a “charge with prorated deposit” for this number.

It’s up the lender if you want to require a separate deposit or just increase the monthly amount proportionally so that by this time next year the escrow account will be back on track.

Cessation of Escrow

Sometimes a borrower wants to pay their taxes and insurance directly, and the lender is comfortable allowing this to happen.  In Moneylender, send the ending date on the escrow charge prior to the first payment that will exclude the escrow amount.  When all payments with escrow are received and all escrow disbursements are paid out, create a final disbursement from the escrow account to the borrower.  You can always resume escrow on the loan later if that is desired by adding a new escrow charge and estimated disbursements.

Thanks for reading our guide on managing escrow.  If you aren’t a Moneylender user already, you should check it out.  It’s pretty much the best loan servicing software available.  At least in my opinion anyway.