In most instances, a monthly mortgage payment is made up of a payment on the principal amount of the mortgage debt which reduces the balance due on the loan, an interest payment which is the charge for use of the borrowed funds, and a reserve payment (also known as an escrow or impound payment) which represents approximately one-twelfth of the estimated annual insurance premiums, property taxes, assessments and other recurring charges.

When settlement occurs you may need to make an initial deposit into the reserve account, otherwise, your regular monthly deposits to it will not accumulate enough to pay the taxes, insurance or other charges when they fall due. Under RESPA, the maximum amount that the lender can require borrowers or prospective borrowers to deposit into a reserve account at settlement is a total gross amount not to exceed the sum of: (a) an amount that would have been sufficient to pay taxes, insurance premiums, or other charges which would have been paid under normal lending practices, and ending on the due date of the first full monthly mortgage installment payment; plus (b) an additional amount not in excess of one-sixth (2 months) of the estimated total amount of taxes, insurance premiums and other charges to be paid on the dates indicated above during any twelve month period to follow.

An illustration will help clarify this calculation. Assume the following set of facts on a loan, and that taxes are paid at the end of the period against which taxes are assessed.

Example:

Settlement date: April 30, 1997

Due Date of first mortgage loan repayment: June 1, 1997

Taxes due yearly: $720.00

Monthly tax accrual $ 60.00

Due date for the taxes December 1st for the calendar year

The reserve amount for category (a) is $360.00. This represents the amount of taxes accruing between December 1, 1996 (the last tax due date) and May 30, 1997 ($60.00 x 6 months). Reserve amounts chargeable under category (b) could be up to two months advance payment times $60.00 or a total of $120.00. Therefore, total reserve deposits for taxes at settlement would be a maximum of $480.00. Changing the due date for taxes and/or the first mortgage payment results in a different reserve amount for the same illustration.

The same procedure is used to determine the maximum amounts that can be collected by the lender for insurance premiums or other charges. You need to know the charges and due dates in order to compute the amounts.

Once you begin your monthly mortgage payments, you cannot be required to pay more that one-twelfth of the annual taxes and other charges each month, unless a larger payment is necessary to make up for deficit in your account or to maintain the cushion of the one-sixth of annual charges mentioned in (b) above. A deficit may be caused, for example, if your taxes or insurance are raised.

You should note that the above monthly mortgage payments reserve limitations apply to all RESPA covered mortgage loan whether they were originated before or after the implementation of RESPA.

Adjustments Between Borrower and Seller

The previous section dealt with setting up and maintaining your reserve account with the lender. At settlement it is also usually necessary to make an adjustment between borrower and seller for property taxes and other charges. This is an entirely separate matter from the initial deposit which the borrower makes into the new reserve account.

The adjustment between borrower and seller are shown in Section J and K of the HUD-1 Settlement Statement. In the example given in the foregoing section, the taxes, which are payable annually, had not yet been paid when the settlement occurs on April 30. The borrower will have to pay a whole year?s taxes on the following December 1. However, the seller lived in the house for the first four months of the year. Thus one-third of the year?s taxes are to be paid by the seller. Accordingly, line 211 and 511 on the HUD-1 Settlement Statement would read as follows:

County taxes

1/1/97 to 4/30/97 $240.00

The borrower would be given credit for this amount in the settlement and the seller would have to pay this amount or count it as a deduction from sums payable to the seller.

In some areas taxes are paid at the beginning of the taxable year. If, in our example, the taxes were paid by the seller on January 1, 1997 for the following tax year ending December 21, 1997, the borrower will have to compensate the seller for the taxes paid by the seller for those months that that the borrower will be in possession of the property (April 20 - December 31). This adjustment will be shown on lines 107 and 407 of the HUD-1 Settlement Statement. With settlement occurring on April 30, those lines will read as follows:

County taxes

4/30/97 to 12/31/97 $480.00

This amount would be credited to the seller in the settlement.

Similar adjustments are made for insurance (if the policy is being kept in effect), special assessments, fuel and other utilities, although the billing periods for these may not always be on an annual basis. Be sure you work out these prorations with the seller prior to settlement. It is wise for you to notify utility companies of the change in ownership and ask for a special reading on the day of settlement, with the bill for presettlement charges to be mailed to the seller at his or her new address. This will eliminate confusion that can result if you are billed for utilities which cover the same time when the seller owned the property.

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