A group of state attorneys general is challenging new federal banking rules that allow certain banks to avoid paying interest on mortgage escrow account balances.
Lawsuit Targets OCC Escrow Rules
Ten state attorneys general filed a lawsuit seeking to invalidate two rules issued by the Office of the Comptroller of the Currency (OCC) that affect how certain federally regulated banks manage mortgage escrow accounts.
The lawsuit, filed in U.S. District Court in Oregon, names the OCC and Comptroller Jonathan Gould as defendants. The new rules allow national banks and federal savings associations to determine escrow account terms, including whether to pay interest or charge fees.
The OCC rules also state that federal law overrides state laws regarding the ability of OCC-regulated banks to determine these escrow account terms. The rules were issued in May and became effective June 18.
How Mortgage Escrow Accounts Work
Mortgage escrow accounts are used by many homeowners to set aside money for expenses such as property taxes, homeowners insurance, and mortgage insurance when required.
About 80% of mortgage holders have an escrow account, according to Lereta. Homeowners without escrow accounts typically pay their taxes and insurance expenses directly.
Because homeowners contribute monthly while taxes and insurance are often paid annually or semiannually, escrow accounts can hold significant balances throughout the year.
States Require Interest Payments
The lawsuit states that 14 states and U.S. territories have laws requiring interest to be paid on mortgage escrow balances. The amount required varies depending on the state.
For example, Rhode Island requires escrow accounts to earn the same interest rate as regular savings accounts, while Maryland requires lenders to pay annual interest based on the yield of one-year U.S. Treasury securities.
The average rate on traditional savings accounts is 0.63%, while one-year Treasury yields are just below 4%. The amount of interest earned depends on the balance calculation method and the applicable interest rate.
Impact on Homeowners
The lawsuit argues that the OCC exceeded its authority by allowing federally regulated banks to bypass state consumer protection laws related to escrow interest payments.
Depending on the state and lender, interest earned on escrow accounts may be credited back to the account or paid directly to the homeowner. In some cases, homeowners may receive a 1099-INT tax form for the interest earned.
Possible Effects on State-Chartered Banks
The new OCC rules directly apply only to national banks and federal savings associations, not state-chartered banks.
However, some states have “wild card” banking provisions that allow state-chartered banks to follow certain federal banking practices if federally regulated banks receive greater flexibility.
Whether banks will immediately change their escrow interest practices remains uncertain, as conflicting court decisions in different federal courts could influence how institutions respond.
