By Jessica Phoonphiphatana, Vice President and Business Operation Manager & Karen Stephens, Vice President and Outsource Manager at LERETA
With new regulations sweeping the financial industry, it is important that bank leadership and lenders do not forget to properly monitor their compliance with existing rules. Regulation AB is such rule that can land lenders in a world of trouble if not followed correctly.
Regulation AB was originally adopted by the Securities and Exchange Commission in 2004. The final rule with substantial modifications was adopted in 2014. The regulation covers asset-backed securities and the information lenders need to disclose for loans on those assets.
A portion of Regulation AB protects borrowers by ensuring that lenders are accurately accounting for all funds taken from the borrower’s escrow accounts. There are certain types of deductions that are not allowed to be taken from the escrow account and cannot be charged as a real estate tax. In addition, these deductions cannot be reported on the borrower’s annual 1098 for tax purposes as they are not tax deductible.
Lenders who service their portfolio for real estate taxes may not be aware of how to properly charge all real estate taxes that are being deducted from escrow accounts. While lenders strive to provide stellar customer service, providing an inaccurate account of the funds being taken from the borrower’s escrow account may result in a borrower complaint. Once an issue is identified, if the lender or servicer is unable to resolve it quickly and accurately, this could possibly escalate into a regulatory complaint to any federal agency, including the new watchdog, the Consumer Financial Protection Bureau (CFPB).
Issues can become problematic even if the homeowner does not escalate the problem to the CFPB, as lenders are still required to comply with CFPB requirements regarding Qualified Written Requests (QWR) and must respond to notices of error. The research involved in resolving QWR’s can be time consuming and costly for the servicer when having to contact the payee to research billing and payment histories. Additionally, many agencies charge large fees for any research conducted. Agencies may also require research requests in writing and can take several weeks to respond. This can be challenging when trying to comply with QWR time limits.
To avoid such complications servicers must be fully aware of what can be accounted as property taxes. As Regulation AB states, “An itemized charge for services to specific property or people is not a tax, even if the charge is paid to the taxing authority.” You cannot deduct the charge as a real estate tax if it is:
A unit fee for the delivery of a service (such as a $10 fee charged for every 2,000 gallons of water you use),
A periodic charge for a residential service (such as a $40 per month or $480 annual fee charged for trash or homeowner’s association collection), or
A flat fee charged for a single service provided by your local government (such as a $50 charge for mowing your lawn because it had grown higher than permitted under a local ordinance).
In order to avoid making a serious mistake that could result in complaints or even worse an investigation with subsequent fines, lenders can work with a tax servicer to assist with properly identifying and setting up their tax deduction types and rules for processing. Lenders who service their own portfolios can ensure their property tax disbursements are recorded correctly by managing and regularly auditing the disbursement types within their servicing system. This should be done for all types of deductions that would be taken from escrow and as it pertains to real estate taxes.
Keeping a watchful eye on existing regulations as well as the new ones will help lenders remain compliant while providing excellent customer service to their borrowers.