Does Your Credit Union Have To Pay Interest On Its Mortgage Escrow Accounts?

That’s the question being raised in a lawsuit that has recently been filed in Brooklyn Federal Court claiming that Bank of America, a federally chartered bank, is acting illegally in refusing to follow New York State law mandating consumers receive minimum interest payments on mortgage escrow accounts. If the case is successful, and as I recently talked about, a similar argument has so far won the day in California, federal credit unions will have to start abiding by New York’s escrow requirements.

First some background. §14-b of New York State’s Banking Law mandates that the Department of Financial Services establish minimum interest payments for mortgage escrow accounts. In conjunction with §5-601 of New York’s General Obligation Law, the statutes mandated up until recently that 2% interest be paid on mortgage escrows. In January, at the urging of both credit unions and banks, the Department of Financial Services used its wildcard power to stipulate that financial institutions are required to pay “the lesser of two percent or the six-month yield on United States Treasury securities on the last business day of the immediately preceding calendar quarter.”

The statute has been around for decades but courts analyzing the issue previously have held that federal law preempts New York’s minimum escrow requirement. For those of you interested in this subject, or who are having trouble getting to sleep, the leading case on this subject is Flagg v. Yonkers Sav. & Loan Ass’n, FA, 396 F.3d 178 (2d Cir. 2005). This amounts to a big savings for federal institutions active in mortgage lending. It is one of the key differences between the state and federal credit union charter. It was passed in the era of double-digit interest rates when it seemed only fair to ensure that mortgage holders received some return on their required escrow accounts;  but in an era of historically low-interest rates, it can squeeze profits.

Now all that might be changing. The Court of Appeals for the 9^th Circuit concluded that federal law does not preempt the ability of Californians  to mandate that federally chartered banks pay escrow interest and now this lawsuit is taking aim at the same practice in New York. At the core of the debate are amendments made to §1639 (Escrow or impound accounts relating to certain consumer credit transactions) in the Dodd-Frank Act. To supporters of this litigation, the statute now clearly mandates that federally chartered institutions provide minimum escrow interest. Conversely, the banks argue that the statute does nothing more than clarify existing preemptive standards.

This might sound like dry stuff but there’s money involved. The plaintiffs in the Bank of America case want to bring a class-action lawsuit seeking damages for the bank’s refusal to provide interest and successful litigation will mean that your federal credit union has to start paying interest. Stay tuned.