Buttons and Levers for Lenders and Debtors

One Thursday afternoon, I told my son that I didn’t want to get anymore emails home from his teacher telling me that “he didn’t finish his classwork at school today.”  I further stated that if an email was sent that he wouldn’t be allowed to play computer games at all that weekend.

Near the end of the school day on Friday, my boy was close to finishing his work, but not quite done.  He and his teacher were having their daily argument about completing classwork.  That’s when my son asked his teacher not to write an email to me because he would lose computer.

Surprise, surprise, I got an email from his teacher that afternoon.  My son told me about what happened during the day, and I had to chuckle a little bit.  Here’s the approximate conversation that ensued.

Dad: If I give you a box with a huge red button on it.  What do you want to do with that button? 

Son: Push it.

Dad: It feels good to be in control of things, doesn’t it?  Like holding the TV remote or being the moderator on a multiplayer game.

Son: Yeah.

Dad: Being out of control is a scary feeling for people.  We all really want to feel like we are the masters of our circumstances.  It feels good to feel like we’re controlling the outcome of things.

Son: Ok

Dad: Your teacher’s job is to make sure that each of her students learns a body of knowledge during their time in fourth grade.  How do you think she feels when a student isn’t showing their understanding of that knowledge?

Son: Bad.

Dad: And do you think she might be scared that she’s not doing a good job if the student isn’t showing that they know all the stuff they’re supposed to know?

Son: Yeah.

Dad: When you told her that she could control your weekend access to video games by writing me an email, you put a big red button in front of her.  You showed her a way that she could have more control over you.  You hadn’t been getting your work done, and here is a big bright button that will make you want to do whatever she wants you to do.  And what happened?

Son: She pushed the button.

Dad: Yep.  That’s what’s happening when someone complains that someone else is pushing their buttons.  A person is using knowledge about some else to manipulate and control them.  I do that with you all the time.  I’m doing it to try to help you make good choices and develop into a person that will be able to thrive in the world.  Sometimes, people will push your buttons for their own selfish reasons.  Sometimes people will push your buttons for good reasons.  Why did your teacher push your button?

Son: She wants me to get my work done.

Dad: Is that a good thing or a bad thing?

Son: A good thing.  She wants me to learn.

Dad: That’s right.  She doesn’t want to hurt you in the long run.  She needs you to be able to get work done at school and she’s trying everything she can think of to guide you to make that decision for yourself.

Son: Yeah.  That makes sense.

Dad: Now what was your mistake here?

Son: Not doing my work at school.

Dad: Well, obviously that’s a problem, but I’m talking about the button.

Son: I showed her the button?

Dad: Bingo.  If you reveal ways that someone can manipulate your situation, chances are that someone will use those buttons to make you act or think the way they want you to.  We don’t need to fear people, or to keep secrets or hide things.  But we also don’t want to enter an interaction with someone by revealing ways that person can exert control over our choices.

 

We learn what our buttons are when people push them and we don’t like it.  And then we learn to limit peoples’ access to our buttons, so that people don’t just push them to manipulate and control us.  But that doesn’t mean our buttons are weaknesses or that pushing our buttons is wrong.

The glue to any negotiation between people, whether it’s an agreement to finish a worksheet before the bell rings or an agreement to repay a million-dollar loan over thirty years, is to communicate clearly and directly.

Herb Cohen’s You Can Negotiate Anything describes the process of communicating effectively when trying to construct an agreement with someone else.  Stephen Covey’s 7 Habits of Highly Effective People describes the painstaking process of uncovering a person’s true desires and motivations, or more accurately positioning yourself so they feel safe enough to reveal those desires to you.  Both authors are concerned with generating the most mutual success from any interaction.  And in both books, finding the path of greatest benefit comes from carefully understanding each other’s goals and motivations and balancing them with equal weight against our own.  Finding ways to make accommodations rather than concessions.

 

I’m in the process of slowly piecing together a chart that shows all the leverage between borrower, lender, myself and my bank for my AutoPay service.  Being able to clearly communicate the ways that the risk is controlled, mitigated, overseen and monitored for every payment that runs through my AutoPay service is an important step in ensuring the payment system is able to run effectively.  Illustrating all the buttons that a borrower can press on the lender, a lender can press on the borrower, the lender and borrower can press on me, and I can press back.  Even the buttons my bank is exposing by making this arrangement and my buttons that can be pressed by the bank.  All of these complex relationships require trust and disclosure to work well.  And also to account for the fact that sometimes people are going to be in a difficult situation, and will make some choices that don’t take into account the best interest of other affected parties.  It’s critical that the right set of buttons and levers are exposed so that someone making a bad decision doesn’t have the chance to create great harm to anyone else.

 

So where am I going with all this?  It comes down to the buttons and levers that we spell out in our agreements with our customers, borrowers, tenants… everyone we interact with from day to day.  In our loan contracts, we spell out which levers will be pulled and which buttons will be pressed under what circumstances. 

Banks make standard mortgages that have a well-defined set of button presses and lever pulls.  Many of Moneylender’s customers are making loans that are not required to follow the same terms.  It is often the case that a deal is struck between lender and borrower as the result of discussion about the unique situation to be financed and finding creative ways to put buttons and levers in the deal where the lender can use them to protect their capital.

 

The buttons and levers must be used with balance, and that balance must be integral to the agreement between borrower and lender.  Virtually every author I’ve read believes in the idea of cooperation, mutual benefit, collaboration, synergy.  The best victory is not where there’s a winner and a loser.  The best victory is where everyone wins.  Not through compromise, but through a deep mutual understanding of each other’s values and needs.

 

The practical application of this point is to communicate the essence of every button and lever with the borrower when exploring and formalizing the deal. 

If the borrower can’t pay right now, here’s how the lender will address that deviation from the ideal path.  Perhaps the missed payment can be overlooked.  Perhaps a fee is charged or interest is capitalized.  Perhaps the lender will immediately take possession of property or assume responsibilities from the borrower.  Is it more desirable for the borrower to bounce a payment or simply not make a payment?  Does the lender want the borrower to reach out by phone or email when a payment is going to be missed, or is there no desire for communication? 

If the borrower can’t pay for a long time, how will both parties address the situation.  Will collateral be collected?  Property taken over or sold?  How desirable or undesirable is a certain outcome to the lender?  Is the lender quite comfortable selling the borrowers house to cover the debt?  Does the borrower know that?  Rather than dragging out a bad situation for a long time, the borrower might have chosen to surrender property if they knew the lender really wouldn’t mind that outcome.  Conversely, the borrower might put more effort into avoiding an outcome if the lender has been clear that selling a house would be a major inconvenience.

What if the collateral doesn’t cover the balance of the loan?  How will borrower and lender handle that situation?  Are both parties in a kind of partnership where a failed deal doesn’t mean there won’t be future deals, or does a failure mean that lender will never work with borrower again?

And for the borrower, how risky does the borrower really think this deal is going to be?  Is there a strong chance the deal might lose money, and the borrower expects the lender to take some of the risk of failure?  Can the lender share in the benefits if a deal is better than the borrower expects?  Does the borrower have instability in their job or income sources that might affect their ability to make consistent payments?  Would it be better if the lender could expect more sporadic payments?

How devastating would a property surrender be to the borrower?  Would giving up a house or a car be traumatic, or does the borrower have only minor attachment to the collateral property?  Will the borrower happily do the legwork to liquidate the property for the lender if the lender deems it necessary?

These lines of inquisition, tailored to the nature of your deal with a borrower, can uncover the real motivations and values for borrower and lender, and help identify unexpected options and opportunities.

 

Communication is so important to any relationship, when business of personal.  Take the time to understand and be understood beforehand.  Reveal your buttons when you’ve established mutual trust.  I suspect you’ll be pleasantly surprised with the outcome.

 

Happy lending!

Josh Whitman, CEO
Whitman Technological Corporation

Moneylender Professional - Loan Servicing Software
My awesome program for managing loans, used by lenders all over the Earth.

Observations on Lending as COVID-19 Spreads Globally

 I hope you’re all safe and healthy out there.  I’m seeing a couple little ripples in lending amongst Moneylender users, and I though you might find the observations interesting.

The story told by Moneylender sales…

Sales slowed for the first several months of the pandemic, and then sort of adjusted back to regular levels.  The collections freezes and proffered forbearances in March and April of 2020 made the lending industry hold its breath.  Once the job situation began to stabilize, we could see who would be losing their jobs and who would remain employed.

We saw a surge in Moneylender sales as people adopted our software to help with their workload as refinances and reinstatements were officially structured into debts around May.  In spite of the surge, the overall sales numbers were depressed throughout 2020, alongside an apparent slump in new debts among Moneylender users, and I would speculate that uncertainty for the future is causing people to avoid new purchases, debts, projects and ventures.  We’re all hunkering down and it’s slowing the use of debt.

While personal, short-term loans still seem to be slower than typical, the very low interest rates available are partially propping up real-estate backed mortgages and other debts that can be refinanced.  New debts are being eschewed while existing debt is generating some churn to keep the industry idling.

The story told by AutoPay payments…

While Moneylender sales are an interesting bellwether for how willing people are to take their chances, the payments through AutoPay have begun to sing the song of how faithfully those chances are being fulfilled.  AutoPay is only in use by a statistically miniscule number of lenders (eighteen at the time of this writing), but patterns are emerging nonetheless.  The lenders using AutoPay are quite varied, and their loans represent a fairly continuous spectrum of the lending industry as a whole.

An important caveat: AutoPay is only able to process payments in the USA, so any meta-analysis of those payments is limited to that single country.  It’s quite likely that the global pandemic is having similar effects in other countries, however.

In the last week of August, it seemed like many borrowers’ bank accounts had simultaneously run dry.  The rate of returns for insufficient funds tripled, and has stayed higher than normal.  Even more stable debts like mortgages saw higher rates of bounced payments.  These higher rates of failed payments are only very slowly tapering off.

Because AutoPay only processes payments and knows nothing of the status of the underlying loans, I could only guess at how loans are performing overall.  What I can tell for sure is that people were taken by surprise by their sudden lack of funds.  Instead of recognizing there would not be enough money and cancelling the payments to avoid NSF and overdraft fees, the payments were allowed to process and fail.  This spanned loans and lenders of all types.

In conclusion…

What useful takeaway might we get from looking into the payments and sales figures?  Certainly that people don’t know what to expect right now, that funds are scarcer than normal, that core income has been affected noticeably, and that many borrowers did not have a contingency plan to fall back on.

You, my savvy lender friends, might offer a contingency plan to your borrowers that allows them to save face and save money in the short term, while ultimately garnering for yourself some additional profit, stability, and loyalty.

Consider your borrowers, consider how you might address unexpected partial or total income loss.  Reach out to your struggling borrowers with a reasonable escape path for them.  If you are careful when you help them out of their difficult situation, you will likely be putting yourself higher on their priorities list.

My standard advice applies even more so when “doing someone a favor.”  Posture yourself as the absolute authority.  The seriousness of the debt, and your credibility must remain fully intact.  If they start to see you like a buddy or a rich aunt/uncle, you will be facing an uphill battle to make a profit from their debt.

Carefully review any letters or conversations you plan to make, ensure your position will confirm in the borrower’s mind that their dutiful repayment is not optional.  Speak calmly and directly, avoid blame or criticism.  State clearly the borrower’s situation and how your propose to allow them to proceed.  Never do this for free.  As soon as you cut them some slack, cutting slack is how you’ll be known.  If you cut some slack, for example, in allowing them to skip a missed payment, you must pick up the slack elsewhere, such as capitalizing the accrued interest.

 

With some though and effort, you can help to relieve your borrower’s immediate worries, enhance their opinion of the debt you hold over them, and make for yourself a little extra coin down the road.  Good luck and happy lending!

-Josh

 If you're in the market for loan servicing software to track and mange your loans, consider using my system - Moneylender Professional.

 

 

Moneylender Professional in 2020

A lot has happened since the last time I posted.  The coronavirus outbreak that causes COVID-19 hit the world and put us all indoors.  I started a YouTube channel.  Moneylender has seen fifteenish updates, adding around 50 new things to the program alongside other fixes and changes.

Monthly sales of Moneylender went up and down during the pandemic.  Overall sales are growing.  In one two-week period we were getting one or two new customers almost daily.  It was an unprecedented rally – surpassing the highs from the December-January surge to set a new monthly all-time record in May.

COVID led to a lot of forbearance and other types of plans to ease the financial burden as businesses were shut down.  I wrote a new section onto the Settings tab – “Special Situations” where you can easily set up any combination of forbearance, reinstatement, waiving or capitalizing interest, and/or adjusting the escrow to be collected.  Of the handful of people that I’ve helped to use the new setting, the response has been very favorable.

I’m seeing a lot of referral sales, and for that I am immensely grateful.  I sent out a few thank you packages to customers that referred others, and that went really well.  I ordered more supplies to make more thank you packages in March, but didn’t want to send them amidst the urgent closures from the pandemic.  As we’re getting a grip on how to treat the virus, I’m looking forward to sending out another batch of thank you packages.

My YouTube channel is currently around 45 subscribers.  It’s not a tremendous number, by any measurement, but my videos are getting consistently better.  Each new video has seen a wider audience and better reception.  I’m also learning to be more proficient with the tools, so the production and editing of the videos has consistently gone up in quality.  It’s been fun to have no agenda for the channel except to share the things that make me happy.  Several videos revolve around Moneylender in one way or another, as it’s a really fascinating project with many opportunities to create things that really benefit people.

While Moneylender appeals to a broad audience, I think it’s really found a special place in the hearts of private lenders and note investors.  There are many large companies that use Moneylender, some have portfolios with 3000 to 5000 loans.  But most lenders that I see have between five and one hundred loans, with portfolios worth six to eight figures.  I’ve seen several nine figure portfolios, and maybe glimpsed a ten-figure portfolio once or twice.

Seeing my little program get such widespread use is a dream come true.  I’m so lucky for each customer that found their way to Moneylender over the years; for the customers that have paid me to add features to the software to meet their needs.  I’m grateful most of all for the people that found Moneylender, and then brought other people to the program.  Nearly half of recent sales say they were referred by a friend.  I am humbled and flattered and grateful.  Thank you, thank you, thank you.

AutoPay has been going very well.  Every month has seen growth over the previous, even in the midst of COVID.  Our sponsor bank, that hesitantly agreed to let me push and pull money, has gone through a couple internal upgrades because we’re using their ACH mechanism more than any other customer.  The AutoPay system is pretty much solid.  All the stumbling blocks for borrowers and lenders have been removed.  I’m looking forward to rolling AutoPay out of Beta and into production in the very near future.

There are lots of other, really exciting features that I’m looking to add.  I’ve heard rumors that .NET 5 will be cross platform.  This means it might be possible to finally get Mac and Linux compatibility.  I have looked, over the years, at getting Moneylender to run on a Mac, but it’s always been about as much work as rewriting the whole program in a different language.

With the ACH mechanisms happily dialed in, I’ll be taking a more serious look into Visa/Mastercard payments through AutoPay, and giving lenders control over the application of convenience fees and which payment types will be accepted.

I still really like the idea of sending SMS messages directly from Moneylender, and I know that’s critical in places where email is not widely used but text messages are.  There are around 150 items on my list of cool suggestions, and perhaps we’ll be seeing more of them getting implemented in the days ahead, too.

The future is bright for Moneylender Professional.  I know my end of the bargain is to keep improving and supporting the program, and it’s a role I’m thrilled to fill.

The best adventures lie ahead of us.

-Josh Whitman, CEO
Whitman Technological

The Secret Sauce to Make Any Business Work

I’ve read a lot of business books.  Books on management, leadership, advertising, marketing, internal processes, hiring, motivational and inspirational books.  I link to think I’m somewhat well read on the subject.  If all these authors were my patient teachers, I don’t doubt I would hear a great collective sigh of relief that I am finally beginning to understand.

Moneylender is the primary product that my company produces.  It’s not surprising that the vast majority of my time is spent on Moneylender-related activities.  For fifteen years, I worked almost every day to build the best solution to the problem of managing loans that I could conceive.  I’m pretty happy with the result, now manifest in Moneylender 3.

That’s great, really it is.  Having a product that holds my complete confidence is a very important part of being a successful business.  But I missed the point.  Sometimes narrowly, sometimes entirely, but I definitely didn’t quite get the reality of the situation as it was being so masterfully described by authors and mentors.

I’m a shy person, of a sort.  I appear outgoing in most social situations, but I’m prefer not to talk much about myself until I feel like I really have the lay of the land.  I want to know how I can best fit into a situation first, and then I will contribute where I feel myself most useful.  It works well for not stepping on toes, listening first and talking second, making a good impression.  Great for a professional in a business community, or at the in-law’s family reunion, but only now do I really see how this attitude has impeded my businesses for the last twenty years.  My confidence in Moneylender at an all-time high, I’m finally willing to show the world all that it is, and I see just how silly my attitude had been across my professional career.

The start of the movie Cabin Boy has an apropos quote: “Nothing so liberates the heart as when a fool awakes from his folly.”

Half the books I’ve read have been sales books, advertising and promotion, marketing books.  I originally drew up the idea for this article around the observation that Richard Gerber’s The eMyth book spent half the time telling the reader to stop pretending the entrepreneurial spirit was some magic essence that some people possessed while others were lacking.  I misunderstood his message at the time.  While I heard “Entrepreneurs aren’t some unique thing, and you either got it or you don’t”, what he was really saying is “forget trying to be an ‘Entrepreneur’ at all, and just do what I tell you.”  If I had really understood the message at the time, I might have dropped my own notion that my software would be the best software and that’s why I would succeed.  His message was, yes, great software is essential, but it won’t make your business successful.

Robert Kiyosaki in Rich Dad, Poor Dad tried fruitlessly to explain the same message to an aspiring writer when he pointed out the key to his success was written right on the cover of his book: “best-selling author”, not “best-writing author”.  Like myself, that hopeful author was unable to cast aside personal visions of the world to hear the message from those that understand.

The ENTIRE second half of The eMyth is how to do marketing.  A subject I had read about so much that I again missed the simple truth.

So now my friends, at last, I get to the point of this article.  Half my efforts must be concerned with the business of getting people to buy my software.  Not one fifth, not one quarter, not 48%.  Half of my effort must be spent on promoting my software, on marketing.

The closest I had ever been to running a truly successful business was when I had very nearly found this ratio by happy accident.  I employed two full-time phone sales people, making cold calls all day long selling websites.  I had a part-time designer, a part-time writer, a part-time coder, and myself.  When the team was at its peak, we could design, write, code, configure, publish, optimize, market and register a website from scratch every three days.  The thing was, I only had two salespeople working full-time.  Making matters worse, while a straightforward and supportive manager, I was undoubtedly inexperienced.  I was in my early-to-mid-twenties, so I can cut myself a little slack.  If I had put a lot more of my attention into helping the salespeople get the tools and resources they needed to be really effective, if I had been willing to monitor and address performance problems among the sales staff, if I had hired two more salespeople.  Had I done those things, I would likely have been very profitable.

It took a full decade of distance to see the simple truth.  These authors are all correct – marketing is the single most important thing a small business does.  If no one know about you, thinks about you, hears about you, then you don’t have any revenue.  It has to be half, too.  The occasional flirt with marketing cannot sustain a real business.  It must be continuous, reliable, repeatable, innovative, collaborative, direct and touching. 

With four salespeople, we would have had a backlog of websites to build, a single person wouldn’t have been able to sink the ship.  There would be no shortage of revenue nor of work for the team.  As luck would have it, both salespeople had personal emergencies at the same time.  As the manager it was my fault for not getting new ones into their seats immediately instead of standing around and scratching my head.

So now, reflecting on the various ruins of my entrepreneurial fits and starts, Moneylender Professional the dogged exception, still bustling amidst the rubble, I can finally say I own this knowledge for myself.  I will, forevermore, dedicate one half of my effort on any venture into marketing.  I will not wait until I feel like my product is absolutely perfect, hiding in my comfort zone.  I will share my efforts happily and purposefully.

I’ll prove my understanding.  I am building a browser game.  It’s a silly game, and at present there’s almost nothing to do in it.  But I have it online, and I’m inviting friends to dink around with it.  I’m posting little status updates to the company Facebook page.  I’m building the game for fun, but I’m taking it seriously.  I’ve been building a robot, too. And I’m posting about that from time to time as well.  These things are well below the “perfection” I’m always chasing, but I need to talk about them.  Marketing for a project is like watering plants.  It will wither and die just the same without the sustaining force of an involved and growing community.

Most of my customers are professional lenders.  And most know that marketing, even when your product is money, is how you find those good borrowers and get those consistent loan payments.  The really desperate borrowers that are rejected by the easy to find lenders might trickle down to more obscure lenders to find a loan.  The creditworthy don’t need to look very hard to find money when they need it.  Most of my customers are WAAAYYYYY ahead of me in learning this lesson, thankfully.

If you’re getting started, or having a hard time finding good borrowers, put half your time into marketing.  Whatever way you can think of to market yourself, try it out and see how it works.  Try lots of things at the same time.  Keep changing it up.  Learn and grow.  Your business will reflect the effort happily on the bottom line.

And, of course, if you manage loans, use Moneylender Professional.  The result of fifteen years of loving craftsmanship.  I just helped a customer do some annual updates and she remarked that “everything you could ever want to do, it’s all just to easy in your software.”  I hope to eventually make that statement true for every customer that uses my system.

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.

Handling Escrow on Your Loans – 1 of 3

The Rules for Lenders

Tracking escrow on mortgage loans is a big deal, and an important part of servicing loans properly.  There are a lot of moving parts to doing it correctly.  What are the rules, how do you track the information about payments you’ve made and will make in the future, how do you decide how much to charge each month so the amount you have in the escrow account is reasonable and legal, what about sending the correct documentation to the borrower and the IRS?  Making a mistake can call into question the validity of your calculations, expose you to fees or penalties, or even put your collateral in jeopardy.

The United States government enacted the Real Estate Settlement Procedures Act (RESPA) in the mid 1970’s to help consumers understand the costs of getting a loan as well as regulate practices that were padding extra fees onto new home loans.  The law also limited how much money lenders could require from their borrowers to keep in an Escrow account.

What the law says is that your lowest balance at the end of any month in a twelve-month period on a mortgage shouldn’t be higher one sixth of the annual expenses to be disbursed.  This means a two-month cushion if all the expenses fall within a single month.  The cushion will be larger if the amounts paid out of the escrow account are scattered throughout the year.

At the beginning of each year, lenders should perform an aggregate accounting for the year using expected payments and expected disbursements from the escrow account to determine the month-end balances.  Each month, starting with the closing balance at the end of the previous month, scheduled payments from the borrower will add money to the escrow account and any disbursements will subtract money out.  After those transactions post, we have the ending balance for the month.  Repeat for each month in the twelve-month period.  That’s the “aggregate accounting” method prescribed for by RESPA.

The IRS requires lenders to send in Form 1098 - Mortgage Interest Statement for all mortgages with $600 or more in interest (including most types of fees) by the end of February if filing on paper, and by April 1^st if filing electronically.  Paper forms must be printed onto official IRS Form 1098 (the red copies) for Filing with the IRS.  Lenders are also required to send copies of form 1098 to their borrowers.  The borrower copies can be substitute forms and are acceptable as long as they have the corresponding information listed in an understandable way.

Up next: Part 2 of the Series – How to do Escrow in Moneylender