Q: We own a house in the District and are in the process of refinancing our present mortgage so we can pull out some of our equity. The new lender has indicated that we will have to make monthly payments into an escrow account so that the lender will be able to pay our real estate taxes as they become due. I thought the D.C. laws prohibited such escrow payments. We also own property in Maryland and Virginia. What are the laws?
A: Unfortunately, the laws here vary greatly on the question of escrow payments for insurance and taxes.
Historically, mortgage lenders have required borrowers to pay a share of the annual taxes and insurance each month. The lender would hold on to these funds, and when the real estate taxes and insurance payments were due, the lender would use the escrow funds for that payment.
During the 1960s, when there was a strong interest in consumerism, many state legislative bodies became sensitive to the fact that mortgage lenders were holding the escrowed funds and were not paying any interest to the borrower. In effect, the mortgage lender had the free use of these funds for long periods of time.
As a result of many court cases as well as pressure on legislative bodies, a number of jurisdictions -- including Maryland and the District -- began to regulate these escrow funds.
In Virginia, however, the combination of a weak consumer organization and a strong lending lobby has kept the Virginia legislature from enacting any consumer protection in this area. Thus in Virginia, the lender if free to require the borrower to pay the escrow for taxes and insurance, without receiving any interest for this money.
In the District, if the borrower makes a down payment of 20 percent or more of the home purchase price, he or she is not required to make any advance payments of real estate taxes or insurance premiums in escrow. Indeed, the lender is obligated to inform borrowers in writing before the loan transaction is completed that they have the right to pay their own taxes and insurance premiums directly.
This law, originally enacted in 1974, applies to all new loans for the purchase of residential property. It does not apply to commercial or investment properties. Additionally, it does not apply to loans make prior to 1974.
A literal reading of D.C. law suggests that there is a gray area when refinance is involved, however. When you buy a house or a condominium, you have an opportunity to put down 20 percent or more of the purchase price. Under those circumstances, the lender cannot require the real estate tax and insurance escrow.
However, when you refinance a piece of property, technically speaking you are not making a down payment of 20 percent or more. For example, if your home is valued at $100,000 and you are refinancing only $70,000, clearly the equity in the property is 30 percent. However, lenders can take the position, by a literal reading of D.C. law, that it only applies to a purchase situation and not to a refinance.
I suggest that this matter of escrow should be discussed in your negotiations with lenders. A lender should be able to comply with the spirit -- as well as the letter -- of the law.
In Maryland, the law is quite different. On any residential loan made after May 31, 1974, a bank, savings bank or savings and loan association doing business in Maryland must pay either 3 percent per annum simple interest or the rate of interest regularly paid on passbook savings accounts for escrows established for the payment of taxes or insurance -- whichever percent is greater.
The lender is required to provide the borrower with an annual statement of the escrow balance. If there is an overage in the escrow account, the lender must inform the borrower in writing at least once a year of the right to either receive a refund of the overage, apply the overage to the payment of principal and interest or leave the overage in the escrow account.
Furthermore, after the lender has informed the borrower of any overage, if the borrower fails to inform the lender of his or her intent within 60 days, the lender is obligated to return the overage to the borrower right away.
Unfortunately, there are many exemptions and loopholes in the Maryland law. First, it doesn't apply to loans made by mortgage bankers. As discussed above, it only applies to mortgage loans made by banks, savings banks or savings and loan associations.
Furthermore, the law does not apply if the loan is purchased by an out-of-state lender through the secondary mortgage lenders -- the Federal National Mortgage Association, the Government National Mortgage Association or the Federal Home Loan Mortgage Corp.