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I am completely lost on how to guide my loan department on this as it is something completely new for me:
This morning our Loan Department sent out an email stating that we are going to be setting up escrow (checking accounts, so not a typical escrow account, but where we are the agent) going forward for our residential construction clients. We will require that our client put 20% in an escrow account before they can advance on the loan. They are wanting to set the accounts up like we do an escrow account when the client has an insurance claim:
Primary would be our bank
MLO would be the authorized signer
Alternate Name would be “Escrow account for XYZ”
Waive any service fees
FNMA states these must be interest bearing
Primary borrower would be set up for alternate tax reporting
No checks or debit card
Have the account marked do not mailDoes anyone see any issues with any of this? Is this something you do at your bank and if so how is it handled there?
We would love to help you but we need a lot more information. What is the purpose of the escrow? Will the construction loan proceeds be disbursed through this account? 20% of what?
20 % of the loan amount. The escrow account would be to help ensure that funds are being used appropriately. Currently funds are placed in a checking account for the client, and often funds are misused. Basically the funds of the construction loan would be held in the escrow account. Once the client needed funds from the account, they would bring in invoices and the MLO would have the ability to cut a cashier’s check to the provider of the service.
Now the picture is becoming more clear.
Most lenders advance construction funds based on inspections conducted by independent experts. This assures construction is actually occurring. While most customers are honest your method leaves open the possibility of fake invoices.
If 20% of the loan amount goes into the account, what happens to the other 80%?
The 20% is like their down payment that they have to place in the account first. After that is used then we will advance from the line.
I have not seen a set-up like this. We have concerns about the deposit account documentation and about the Loan Estimate and the Closing Disclosure. We will get back to you on these matters.
We also hope others may have seen this arrangement and will chime in.
I’m glad Jack got some more details on your situation. If I understand correctly, you have been giving funds directly to your borrower and to pay the construction costs; this has been an issue with proceeds not actually being used for construction costs and you are trying to ensure that what is being disbursed to the borrower is for construction costs/the work is being done. As Jack mentioned that many banks have an inspection process/policy in place for disbursing proceeds.
A little research shows there are various ways banks handle this control function. Some use a existing DDA or open a new DDA and take a security interest, some might us a DDA, SAV or GL as an escrow account. If the customer is opening – it is a consumer account – then consumer disclosures would apply. As a reminder, it might be worth reviewing this old opinion letter from the FDIC addressing insurance on escrowed funds and how to make sure you have documented the account sufficiently: https://www.fdic.gov/regulations/laws/rules/4000-7550.html.
“The FDIC will not recognize a claim for insurance coverage based on a fiduciary relationship which is not evident from the deposit account records of the insured institution. 12 C.F.R. § 330.4(b). Deposit account records must expressly disclose, by specific reference, the existence of any fiduciary relationship, including relationships involving a custodian, pursuant to which funds in an account are deposited and on which a claim for insurance coverage is based. Id.”
I’m also hoping some others will tell us what their process is.
Our bank works similar to the process Jack mentioned. The borrower sets up a checking account in their name. When the borrowers existing funds have been depleted, we structure advances based on the phase of construction completed. We have inspections conducted by independent experts, usually the appraiser. If the inspection corresponds with the funds already advanced, then additional funds are moved to the checking account. The phase of construction determines the amount of the advances. I would be concerned with the potential liability on the bank and the MLO in the structure mentioned. I agree with Jack that most borrowers are honest and if the borrower is that questionable, maybe the loan should not be approved. Hope this helps!
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