The phrase “payment shock” will typically evoke an emotional response from mortgage servicers. When a new customer’s monthly payment increases beyond what was expected, it can negatively affect both the consumer and the lender. One of the common causes of these payment-shock scenarios is when a property’s taxes are not fully assessed at the time of closing. Normally, tax re-assessments will occur after improvements to the property have been completed but may happen after the closing of the mortgage loan. If a customer has an escrow account for the payment of property taxes, a higher tax bill will ultimately impact the customer’s mortgage payment. If the amount collected at closing was not sufficient and does not reflect the fully assessed amount, the customer could be shocked at the new payment.
A dramatic increase in the monthly payment will undoubtedly lead to phone calls, correspondence and complaints from customers who may not now be able to afford the higher payment.
There are two time periods in which lenders, servicers and consumers need to be aware and take action in order to prevent payment shock as a result of taxes not being assessed.
First is at origination and second is during the escrow analysis periods for the first year of the loan. Depending on the timing of the re-assessment, the second year may also be an impact period.
Loan Origination
Normally, lenders use prior years’ tax bills to estimate escrow impounds at the time of closing. This is usually a reliable method for estimation, but is problematic when the property’s current taxes are based only on the value of the land. When this is the case, the lender must estimate what that bill will be after re-assessment and collect impound amounts based on that estimate.
Dodd-Frank provided some level of clarity in that this estimation is now required by creditors for property taxes based on “the taxable assessed value of the real property securing the transaction after the consummation of the transaction.”
This avoids a potential pitfall where the initial escrow deposits only reflect a lower assessed tax bill based solely on the value of the land. Disclosure provisions also provide the consumer with notification that the amount of escrows may increase.
What is still unclear for many lenders is how to properly estimate the tax bill. The expectation from the Consumer Financial Protection Bureau is that lenders and servicers determine the proper method for computing the estimated taxes. Availability of data to compute such estimates can vary by state as well as locality.
Generally, estimates can be based on like properties that have been assessed if that information is available. Otherwise, 1% to 5% of the purchase price can be a reliable estimate.
The importance of communication with the consumer cannot be overstated. In addition to the required disclosures, the lender should ensure that guidelines include informing consumers that their payment will increase upon full assessment and that an escrow overage may be sent to them if the reassessment does not occur by the time they receive their first escrow analysis.
Servicing
Ideally, the reassessment will occur within the first calendar year, but in some taxing jurisdictions the reassessment may take a considerable amount of time to complete. When servicing a loan, it’s critical that lenders monitor the status of the assessment. If the estimation rules are followed at closing, an escrow analysis performed in the first year with payments to the tax authority at the lesser land-only amount will generally result in an escrow overage.
The Real Estate Settlement Procedures Act requires lenders to refund escrow overages greater than $50 to the consumer. The following year, the consumer may now have sufficient funds in the escrow account resulting in an escrow shortage. This can be a very frustrating scenario for the consumer. Servicers should be cautious not to update the tax amount used for calculating required escrows with that land-only amount.
If the amount is not maintained at the estimated figure, the subsequent analysis will appear to require significantly less funding for future tax bills. An uninformed consumer may unfortunately use those funds for other purposes. A later analysis after the fully assessed amount is paid could result in a large shortage and a shocked consumer.
If the estimation rules were not followed at the time of closing, the consumer will be affected by a large shortage when the escrow analysis is run following the payment of the fully-assessed tax bill. For the uninformed consumer, repayment of this shortage and the need to collect for future higher tax bills can be a significant burden that could potentially lead to loan default.
If escrow funds continue to be collected at the estimated amount, they will accumulate in the consumer’s escrow account and
be available when the fully assessed bill is paid. Should the analysis be performed before the re-assessment, it also may generate an escrow overage if a land-only tax amount is paid.
When the overages are refunded, communication with the consumer is critical to create awareness that those funds may be needed to pay taxes once the re-assessment is completed. It is important to advise the consumer that it is recommended to redeposit those funds in their escrow account to avoid future escrow shortages.
In some cases, the consumer may wish to retain the escrow overage funds. This is
an acceptable choice for a consumer
who understands the implications of the future increase.
Clear Lines of Communication
Multiple communication tactics should be employed to ensure the consumer understands the assessment process. Lenders and servicers alike should consider written correspondence during the first year to help ensure that the consumer is aware of the effect that their property tax assessment can have on their overall mortgage payment.
Some suggestions include website notifications and FAQs, text and email alerts and a clear notation on the escrow analysis itself. Notifications should be sent with any overage check issued, again letting the consumer know about the potential effect.
Call-center employees should be trained to recognize the situation as well. Implementing procedures are critical to ensure that consumers receive clear communication and are advised in the event they receive an overage check resulting from a tax payment on a not-fully-assessed property.
The complexity of this situation due to the variation of assessment timing from jurisdiction to jurisdiction makes it extremely important that compliance and legal teams are always consulted when drafting
policies to ensure adherence to state and federal regulations.
Payment shock can be a very difficult situation for consumers and lenders alike. Clear, consistent policies at both loan origination and through to servicing that consider the potential for dramatic increases in payments can help prevent fallout.
Clear and frequent dialog is the ultimate tool to remove the shock that can occur when a customer faces an increase in their mortgage payment tied to the re-assessment of their property taxes.
