Under the new HPML requirements, we must keep escrow accounts for HPMLs open for five years. However, what if Illinois law permits a borrower to cancel the escrow before the five years is up?

In the context of mortgage escrow accounts, to the extent that a federal requirement conflicts with the Illinois law, federal law will preempt the state law. Olsen v. Financial Fed. Sav. & Loan Ass’n, 105 Ill.App.3d 364, 371 (1st Dist. 1982). (This is not always the case, as some federal laws expressly allow state law to trump the federal law, for example, where a state law provides stronger consumer protections.)

Therefore, if any of the requirements in the Illinois Mortgage Escrow Account Act conflict with federal regulations, such as the higher-priced mortgage loan rules, then the bank must follow the federal regulatory requirements. Section 5 of the Illinois law requires lenders to notify mortgage borrowers when the loan principal is reduced to 65% of its original amount. Further, that section requires lenders to to terminate the escrow account on the borrower’s request. 765 ILCS 910/5.

We believe that those requirements in Section 5 conflict with the federal higher-priced mortgage loan regulations, which currently require lenders to maintain escrow accounts for the first 365 days after the loan consummation. 12 CFR 1026.35(b)(3)(iii). (And, as you noted, the Dodd-Frank Act expanded this time period to five years and added further preconditions that must be met before terminating an escrow account. The implementing CFPB rules will go into effect June 1, 2013. 78 Fed. Reg. 4725, 4754 (January 22, 2013).) Therefore, if federal law requires that the bank maintain an escrow account, you must keep it open, even if the Illinois law allows the borrower to cancel the account.

Also, note that Section 7 of the Mortgage Escrow Account Act exempts mortgages guaranteed by the federal government from Section 5 of the Act. 765 ILCS 910/7 (“The borrower shall not have the right to terminate any such arrangement under Section 5 in conjunction with mortgages insured, guaranteed, supplemented, or assisted by the State of Illinois or the federal government that require an escrow arrangement for their continuation”). However, it does not exempt higher-priced mortgage loans generally from the cancellation right in Section 5.