We previously covered the CFPB’s issuance of final rules on Ability-to-Repay and Qualified Mortgages together with the expansion of HOEPA coverage under the Dodd-Frank Act (DFA). Here we review the final escrow rules and suggest that they reveal a line the Bureau intends to consistently draw—under its exemption authority—between large and small mortgage lenders (at $2 billion). The Bureau’s final escrow rules take effect on June 1, 2013.

“Higher-priced mortgage loans” are a class of mortgages carrying APRs that are comparatively high but not high enough to trigger the full HOEPA protections implicated by “high-cost mortgages” (a.k.a. “HOEPA loans”). Under 2008 Federal Reserve amendments to Regulation Z, however, creditors must meet a number of requirements in conjunction with the origination of higher-priced mortgage loans, including the establishment and maintenance of escrow accounts for at least one year after origination. These escrow accounts set aside consumer funds on their behalf to pay property taxes, mortgage insurance premiums, and other mortgage-related insurance required by the creditor.

In its 2008 rulemaking, the Federal Reserve concluded that it was “unfair for a creditor to make a higher-priced loan without presenting the consumer a genuine opportunity to escrow.” The agency’s evidence suggested then that few subprime mortgage creditors provided for escrow accounts.

Congress liked these Fed rules enough to codify them, with certain differences, through Dodd-Frank. A key difference (and one on which the CFPB was left with little room for discretion under the statute) is the extension of the general term of the creditor’s duty to maintain escrow accounts after origination from one year to five. The DFA escrow provisions also adjusted the threshold rate above the average prime offer rate determining when escrow accounts are required for “jumbo” loans.

One notable discretionary aspect of the CFPB’s final escrow rule is that it varied from the Federal Reserve’s proposal in order to, in the view of the Bureau, harmonize Dodd-Frank’s small creditor-balloon payment qualified mortgage exemption and the Act’s separate small creditor escrow account exemption. Indeed, the statutory criteria are nearly the same. In support of its adoption of both carve-outs, the Bureau cited the risk of reducing credit availability in rural markets and the significantly lower mortgage delinquency and charge-off rates under “the community bank” model. The Bureau essentially adopted the qualified mortgage versions of the overlapping criteria in both final rules.

Under the new rule, a creditor will not be required to establish an escrow account for a loan if, at the time of consummation of the transaction, the following conditions are satisfied:

(1) During the preceding calendar year, the creditor made more than 50 percent of its first-lien covered transactions on properties located in counties designated by the Bureau as “rural” or “underserved”;

(2) During the preceding calendar year, the creditor and all of its affiliates together originated 500 or fewer first-lien covered transactions;

(3) The creditor must have had total assets of less than $2 billion in the preceding calendar year, adjusted annually for inflation;

(4) Neither the creditor nor its affiliates maintain an escrow account for property taxes and mortgage-related insurance for any consumer credit secured by real property or a dwelling that the creditor or its affiliate services, except in limited circumstances; and

(5) A loan would not qualify for the exemption if it is subject to a commitment to be acquired by a person that does not also satisfy the foregoing conditions (unless the loan is separately exempt from the rule, such as if the loan is a transaction to finance the initial construction of a dwelling).

The asset size mark was based on Federal Reserve analysis within the proposed rule suggesting that, of the creditors that made more than 50 percent of first-lien mortgages in “rural” or “underserved” counties (i.e., they met the first criteria above) as of the end of 2009, none were larger than $2 billion. The Bureau endorsed this formulation and also indicated in its final escrow rule that it was important to establish both an origination- and asset size-based limitation in order to prevent larger creditors with a modest mortgage business to take advantage of the exemption.

The CFPB stated in its final escrow rule that it views all of its pending DFA Title XIV rulemakings as part of “a single, comprehensive undertaking.” For this reason, we do not think it is likely to establish an exemption for small lenders under the QM rules—it proposed a broad, higher APR-loan exemption on January 10—that is inconsistent with the $2 billion/500 annual originations threshold.

The DFA also codified and the Bureau issued rules implementing the escrow account exemption for loans secured by condominium units—creditors need not escrow funds to cover mortgage-related insurance—and expands it to other, similar ownership arrangements involving governing associations that have an obligation to maintain a master insurance policy.