A customer obtained a higher-priced residential mortgage loan in 2011. The borrower has never requested to cancel the escrow account. Two years ago, the borrower entered into a contract for deed with a buyer for the home securing the loan. The customer provided proof that he canceled his homeowner’s insurance policy and that the buyer had obtained a new policy and was paying the premiums. But we never updated our system, and we continued to deduct insurance payments from the borrower’s loan payments and place them in escrow, without paying out any insurance premiums. Now there is an excess of funds in the escrow account, and we are facing two issues. First, can we terminate the escrow account? The borrower is in a nursing home, appears to be incapacitated and has executed a power of attorney, but the agent under the power of attorney has refused to terminate the escrow fund. Second, can we use the excess funds in the escrow account for the borrower’s loan payment, which is now overdue?

While we address your specific questions below, we strongly recommend consulting with an attorney, as your bank could face liability under the Real Estate Settlement Procedures Act (RESPA), and possibly other laws, for the failure to discontinue collecting amounts for the cancelled homeowner’s insurance. Additionally, if the property securing the loan is subject to a contract for deed — possibly in violation of your mortgage loan agreement or note — your bank may need to take swift action to protect its security interest in the home from the buyer’s competing interest.

We do not recommend terminating the escrow account without a request from the borrower. Under the rule in effect at the time you made the loan, and under the current rule, your bank is permitted to cancel an escrow account for a higher-priced mortgage loan only in response to the customer’s request. In this case, you have not received a request to terminate the account, and the borrower’s agent has specifically refused to permit your bank to terminate the escrow account. Additionally, Regulation Z does not permit lenders to cancel an escrow account for a higher-priced mortgage loan if the loan is in default. Consequently, it appears that your bank has no legal basis for canceling the escrow account.

We also do not recommend applying the escrow account’s surplus to the overdue loan payment. If a borrower is delinquent, Regulation X does permit a bank to retain an escrow surplus, but the surplus must be retained in the escrow account, and even this action must be permitted by the terms of your loan agreement with the customer. The same provision in Regulation X appears to prohibit a lender from moving surplus escrow funds out of the escrow account (for example, by applying the surplus to the outstanding loan balance).

Additionally, your bank may be facing a RESPA violation due to the collection of excess escrow funds. Under the RESPA and Regulation X, you may not require escrow payments of more than 1/12 of the reasonably anticipated escrow charges, plus a cushion of no more than 1/6 of that amount. If the amounts collected for the homeowner’s insurance exceed those limits, then your bank likely is in violation of these requirements.

For resources related to our guidance, please see:

Regulation Z, 12 CFR 1026.35(b)(3) (“Except as provided in paragraph (b)(3)(ii) of this section, a creditor or servicer may cancel an escrow account required in paragraph (b)(1) of this section only upon the earlier of: (A) Termination of the underlying debt obligation; or (B) Receipt no earlier than five years after consummation of a consumer’s request to cancel the escrow account.”)

Former Regulation Z, 12 CFR 1026.35(b)(3)(iii), 73 Fed. Reg. 44522, 44604 (effective April 1, 2010 to June 1, 2013) (“Cancellation. A creditor or servicer may permit a consumer to cancel the escrow account required in paragraph (b)(3)(i) of this section only in response to a consumer’s dated written request to cancel the escrow account that is received no earlier than 365 days after consummation.”)

Regulation Z, 12 CFR 1026.35(b)(3)(i) (“Except as provided in paragraph (b)(3)(ii) of this section, a creditor or servicer may cancel an escrow account required in paragraph (b)(1) of this section only upon the earlier of: (A) Termination of the underlying debt obligation; or (B) Receipt no earlier than five years after consummation of a consumer’s request to cancel the escrow account.”)

Regulation Z, 12 CFR 1026.35(b)(3)(ii) (“Notwithstanding paragraph (b)(3)(i) of this section, a creditor or servicer shall not cancel an escrow account pursuant to a consumer’s request described in paragraph (b)(3)(i)(B) of this section unless the following conditions are satisfied: . . . (B) The consumer currently is not delinquent or in default on the underlying debt obligation.”)

Regulation X, 12 CFR 1024.17(c)(1) (“A lender or servicer (hereafter servicer) shall not require a borrower to deposit into any escrow account, created in connection with a federally related mortgage loan, more than the following amounts: . . . (ii) Throughout the life of an escrow account, the servicer may charge the borrower a monthly sum equal to one-twelfth (1/12) of the total annual escrow payments which the servicer reasonably anticipates paying from the account. In addition, the servicer may add an amount to maintain a cushion no greater than one-sixth (1/6) of the estimated total annual payments from the account. . . .”)

Regulation X, 12 CFR 1024.17(f)(2)(i) (“If an escrow account analysis discloses a surplus, the servicer shall, within 30 days from the date of the analysis, refund the surplus to the borrower if the surplus is greater than or equal to 50 dollars ($50). If the surplus is less than 50 dollars ($50), the servicer may refund such amount to the borrower, or credit such amount against the next year’s escrow payments.”)

Regulation X, 12 CFR 1024.17(f)(2)(ii) (“These provisions regarding surpluses apply if the borrower is current at the time of the escrow account analysis. A borrower is current if the servicer receives the borrower’s payments within 30 days of the payment due date. If the servicer does not receive the borrower’s payment within 30 days of the payment due date, then the servicer may retain the surplus in the escrow account pursuant to the terms of the federally related mortgage loan documents.”)