For our Fannie Mae loans, we place property insurance claim proceeds being held for future repairs in custodial accounts under our bank’s TIN (to avoid issues with the accounts showing up under the borrower’s TIN for data match and subpoena searches). We recently discovered that the Fannie Mae Servicing Guide requires us to pay interest on these funds, so we will have to move them into interest-bearing accounts. How can we properly report the interest earned on these accounts without making the funds susceptible to a levy or garnishment?

As you noted, the Fannie Mae Servicing Guide requires servicers to place insurance loss proceeds that have not been disbursed to the borrower (or a contractor) in interest-bearing custodial accounts. We agree that you should continue to use the bank’s TIN on these accounts, in order to indicate they are custodial accounts that are shielded from garnishment or levy.

The custodial accounts — including their accumulated interest — should be shielded from garnishment or levy because the Fannie Mae Servicing Guide prohibits a borrower from receiving the benefit of these funds until certain specified conditions are met, and a judgment creditor has no greater rights than the judgment debtor. But once the accumulated interest has been disbursed to the borrower, these funds lose this protection, and if they are moved to a non-custodial account at the bank, then they would be subject to garnishment or levy.

While accumulated interest in the custodial accounts likely should be reported on IRS Form 1099-INT even prior to their disbursement, as noted above, we believe the Fannie Mae requirements should shield this accumulated interest from garnishment or levy irrespective of the reporting.

For resources related to our guidance, please see:

Fannie Mae Servicing Guide, B-5-01: Insured Loss Events (April 11, 2018) (“The servicer must deposit the insurance loss proceeds not disbursed to the borrower in an interest-bearing account. . . . The interest-bearing account must . . .

Be a T&I custodial account with a depository institution that meets Fannie Mae’s eligibility criteria for custodial depositories.

. . . .

Yield interest equivalent to the interest the borrower could expect to obtain from a savings or money market account.”)

Fannie Mae Servicing Guide, B-5-01: Insured Loss Events (April 11, 2018) (“The servicer must pay the accumulated interest to the borrower once the repairs to the property have been completed, unless

the borrower requests an earlier disbursement of the interest, or

applicable law allows for the accumulated interest to be applied to the UPB.”)

FDIC Brochure, Your Insured Deposits (“Although mortgage servicers often collect and escrow tax and insurance (T&I), these accounts are separately maintained and not considered mortgage servicing accounts for deposit insurance purposes. T&I deposits belong to the mortgagors pending payment of their real estate taxes and/ or property insurance premium to the taxing authority or insurance company. The T&I deposits are insured on a ‘pass-through’ basis to each individual mortgagor.”)

Marscheschi v. P.I. Corp., 84 Ill.App.3d 873, 879 (1st Dist. 1980) (“The purpose of the Garnishment Act is to make assets belonging to a judgment debtor available for the satisfaction of an underlying judgment. In determining the rights of a judgment creditor against a garnishee, the judgment creditor stands in the shoes of the judgment debtor. In order to impose liability on a garnishee, the judgment creditor must assert a claim against the garnishee which the judgment debtor himself could have maintained. . . .”)

Baird v. Senne, 13 Ill.App.3d 226, 228 (1st Dist. 1973) (“[T]he uncontradicted evidence does establish that, on the date the garnishment summons was served on the garnishee bank, the funds in question did not belong to defendant, but equitably belonged to either Slaton Furs or the fur coat buyer depending on whether or not the fur coat had been delivered. Therefore, since the money did not belong to defendant it was not subject to garnishment.”)

Avila v. CitiMortgage, Inc., 801 F.3d 777, 786 (7th Cir. 2015) (“Section 5 [of the Fannie Mae/Freddie Mac Uniform Instrument for single-family homes in Illinois] . . . gives CitiMortgage the right to apply insurance proceeds toward the outstanding loan balance under certain specified conditions, including the homeowner’s abandonment of the property or foreclosure by CitiMortgage. . . .”)

IRS Form 1099-INT Instructions, Box 1. Interest Income (“. . . Include amounts of $10 or more, whether or not designated as interest, that are paid or credited to the person's account by savings and loan associations, mutual savings banks not having capital stock represented by shares, building and loan associations, cooperative banks, homestead associations, credit unions, or similar organizations. Include interest on bank deposits . . . .”)