Introduction
Suppose you're a a mortgage lender, and you issue a loan on a property. In addition to making payments on their mortgage, the borrower also has to pay property taxes, and should definitely get insurance on the house. Now, as the lender, you mostly care about the payments to you, but you also recognize that if the borrower skips on paying taxes or insurance, you're probably not going to get paid.
That's where escrow management comes in: In addition to your regular payments, fees, and charges, you require borrowers to pay into an 'escrow bucket', and then you use the money in that bucket to pay the insurance and taxes. If the borrower stops paying you, you'll be better equipped to repossess the property and minimize liabilities.
In LMS, you can use escrow management to add amounts to regularly scheduled payments, distinct from regular principal, interest, and charges. The rest of this article will explain how escrow works from a high-level, and then our other articles, like Creating Escrow Buckets and Creating Escrow Adjustments, will show the actual buttons and clicks you need to make in the software.
Use Case: Taxes & Insurance Tracking
Use Case: Escrow/Taxes & Insurance Tracking
The Problem:
A lender gives out loans that use homes and cars as collateral. They've realized, though, that borrowers are seldom willing to make payments on houses that burned down, cars that were totaled, or anything that the government seized in a tax settlement. The lender, then, naturally wants borrowers pay their taxes, insurance, and any other bills that would make sure the collateral stays in good condition and out of Uncle Sam's hands. They would like the borrower to pay them all the money directly, and then they can disburse it to the insurance companies and governments that it needs to go to. But that's a lot to keep track of, all on top of the loan's normal payment schedule.
LoanPro's Solution:
This is a perfect use for the escrow tools in LMS. Escrow lets you organize payments for taxes, insurance, or auto maintenance into buckets. You can set up escrow payments to be collected along with the loan's regular payments, and determine whether they show up in the loan's amortization schedule, are used to calculate APR, and are included in TILA disclosures. The borrower is saved the trouble of sending money to three or four different places, and you can rest easy knowing the taxes and insurance are paid up.
Use Case: CSO Model
Use Case: Escrow/CSO Model
The Problem:
A lender works with a credit services organization (CSO) to find new customers. Borrowers will first meet with the CSO, who then finds them a lender willing to offer them a loan. Part of the agreement is that as the borrower pays back the lender, they pay a fee to the CSO. But the lender wants to make repayment as convenient as possible for their borrowers, and having them make separate payments to the CSO would definitely complicate things.
LoanPro's Solution:
You should use our escrow tool to fit those CSO payments seamlessly into the loan's regular due dates. Escrow lets you add additional payments that come due at the same time, but aren't part of your regular principal, interest, or fees. Repayment will stay simple for borrowers, and you'll have a record of how much money has been paid toward the CSO.
Highlights
In LMS, you can create escrow buckets at the tenant level. Like our hypothetical mortgage broker, you create buckets for property tax and sales tax. Whatever kind of escrow you want to collect, you can create a tenant-level bucket for it.
Within an individual loan, you can add edit the settings of that bucket to fine-tune it to that account. When the settings are configured to your liking, you'll add an escrow adjustment to specify how much you want to set aside for a particular bucket in each payment period. After the adjustment has been made, the system will take a portion of every payment and apply it to that escrow bucket.
Escrow Management is part of your payment waterfall application. If a borrower pays less than they're supposed to and an escrow bucket is at the bottom of the waterfall, that bucket will get less than the adjustment says it should—it might not get anything. If keeping that escrow bucket paid in full is important to your business model (like taxes or insurance might be), then we recommend prioritizing it in the waterfall application.
When you do need to use the money you've collected in an escrow bucket, you'll log an escrow transaction. You might make escrow transactions regularly, like paying taxes or an insurance deductible, or it might be an irregular event, like paying an insurance premium after an accident. Between adjustments and transactions, you'll be able to manage how money accumulates in an escrow bucket and where it goes afterwards.
Where Does Escrow Fit?
Escrow is traditionally used on mortgages, but other lenders make use of it as well. If you lease cars, for instance, you might use escrow for sales tax on the the vehicle, or to pay for membership in an 'auto club' where the car can be regularly serviced. (Lessees like auto clubs because they can get their car serviced at a discounted rate, and lessors like them because it helps protect the collateral so it can be leased again in the future.)
Another use for escrow buckets is to pay Credit Services Organizations (CSOs). These companies connect potential borrowers to lenders. In return for that service, they generally receive payments from the borrower as they pay back their loan. Some CSOs have a closer relationship to lenders as well: In states like Ohio and Texas, where laws prohibit high interest rates, lenders can partner with a CSO to collect more from borrowers without violating usury laws.
How you use escrow buckets (and whether you use them at all) will depend on your business model. Ultimately, the escrow features in the software are versatile, and could be put to use in new ways that we haven't described here. You might consider using escrow for any type of money that comes from the borrower and is then redirected to another source.
This Feature is Not
Let's take a second to clear up any possible misunderstandings:
- Escrow shouldn't be used for convenience fees. You can, but we have better tools.
- The escrow transactions do not move actual funds. When you process a payment from a bank card or account, LoanPro's integrated processors move the borrower's money into your account.
- Escrow is not the Wild West. There are a lot of laws and regulations governing when you can and can't charge for escrow, how much those charges can be, and what you need to tell your borrowers. We recommend you work with your compliance officer or legal team to make sure you stay on the right side of the law.
What’s Next?
If you're creating loans with escrow buckets, you can use the Escrow Calculator, which helps develop amortization schedules with escrow payments in mind. Escrow Analysis can help you draft documents to disclose escrow information to your borrowers.
Written by Andy Morrise
Updated on March 28th, 2024