With regional banks in trouble, the money waiting to complete local home sales could be under-insured.
By JEFF LAZERSON | firstname.lastname@example.org | MortgageGrader.com | May 15, 2023
Article originally posted in Orange County Register on May 04, 2023.
Missing from the headlines of regional bank collapses in recent weeks was the mention of real estate transactional risk.
Homebuyers and sellers, this is something for you to start thinking about since banks are dropping like dominoes. Three to fall were Signature Bank, Silicon Valley Bank, and most recently, First Republic Bank. First Republic was the second-biggest bank crash in American history.
More recently, PacWest Bancorp and Western Alliance made the news over their stock price volatility.
Today, we turn our attention to escrow trust accounts, which do not offer any additional layers of FDIC protection when buying or selling a home than traditional checking, savings and money market accounts. It’s all the same.
And in high-cost California, those escrow accounts often hold tidy sums of money well above the $250,000 cap for federal insurance.
And adding to the concerns, if your escrow company’s bank is coincidentally your personal bank, you may have less FDIC insurance protection because the cap is $250,000 per person, per bank. It’s not per bank account, per person at one institution, according to Jessica Felton, a lawyer at the firm RELAW in Westlake Village.
“Funds in an escrow company’s trust account are insured just like other accounts, each depositor person (natural person or legal entity with a separate tax ID number) is insured up to their limit ($250,000) for all funds held at that particular financial institution,” said Felton. “Escrow companies often hold significantly more (than) the limit amount for individuals, which would not be insured if the bank failed.”
Full disclosure: I have an ownership interest in Prosper Escrow Corp. at which Felton is legal counsel.
“The party insured is the depositor (for escrow that’s generally the buyer), not the potential beneficiary (for escrow that’s generally the seller) until the transaction closes. So, if we have a transaction with two buyers and two sellers, it is only insured for the two buyers ($500,000 total) up until closing. After it closes, that would shift and the seller would be insured on the funds, not the buyer. Only one side can be entitled to the funds at any given time,” said Felton.
“The average deposit is 3% of the sales price,” said Felton. For example, on a $1 million sales price, 3% would be $30,000.
So, what is the fuss, you ask, if you are covered up to $250,000?
Well, the borrower will need to bring in the rest of the down payment and deposit it into escrow before the lender funds the loan. How much could that be? A lot!
Let’s ponder the risks for someone buying that $1 million home mentioned above.
Say the borrower’s mortgage is $600,000, meaning they’re putting down an impressive $370,000 in addition to the initial earnest money deposit. Don’t forget about buyers’ side closing costs, too.
Whether it’s your money or mom and dad gave you a ginormous gift, the potential exposure is still there. Banks crash.
A seller’s exposure occurs when the buyer and the buyers’ lender pay you off (assuming it’s not an all-cash deal). You have a million dollars sitting in escrow with just $250,000 of insurance. Can you say exposure?
So, be sure to check out the escrow company and not just the bank. Under federal law, the buyer chooses their settlement servicer. In practice, it’s the real estate agents or builder who steers this business.
Southern California resale real estate transactions are arranged through escrow companies licensed and regulated by the Department of Financial Protection and Innovation.
Or California-licensed real estate brokerages may have in-house escrow companies licensed and regulated by the same California Department of Real Estate. The real estate brokerage’s escrow must have a dog in the fight to participate. It must be representing a principal (buyer, seller or both or arranging the mortgage financing). Otherwise, broker-owned escrows cannot participate.
It’s common to see Southern California homebuilders with new tracts engage with title insurance companies, which provide both escrow and title insurance services. Title companies are licensed and regulated by the California Department of Insurance.
Escrow companies licensed by DFPI must go through what seems like a Secret Service-type background check prior to licensing. And all workers must have their information (photos, fingerprints, etc.) submitted to the DFPI (via the Escrow Agents Fidelity Corp.) within 10 business days of employment.
Escrow companies tend to keep substantial amounts of money in their trust accounts. The DFPI wants to avoid seeing any escrow company on tomorrow’s newspaper’s front page for absconding trust funds.
While the California Department of Real Estate has a reputation of being a mean dog on a short leash when it comes to enforcement, in-house real estate broker-owned escrow companies do not have anywhere near the oversight rigor mandated by the DFPI. I “thank” the political influence of the California Association of Realtors for these standards.
America has a plethora of economic headwinds right now. To name just three, we have a debt ceiling coming due with congressional Democrats and Republicans playing chicken with each other. The Federal Reserve is struggling with ways to tame inflation-increasing the prime borrowing rate on May 3 to 8.25%. (It was less than half of that at 4% on May 4, 2022.) And, Wall Street has major concerns about the stability of the banking system.
How else can you protect yourself especially when big bucks are involved?
Felton points out there is additional FDIC insurance coverage accessible beyond the $250,000 — if you’re willing to pay for it.
She also recommends you direct the escrow officer to set up a separate interest-bearing trust account for your trust funds. No need to combine your funds with the other trust funds and the primary trust account.
Freddie Mac rate news: The 30-year fixed rate averaged 6.39%, 4 basis points lower than last week. The 15-year fixed rate averaged 5.76%, 5 basis points higher than last week.
The Mortgage Bankers Association reported a 1.2% mortgage application decrease from last week.
Bottom line: Assuming a borrower gets the average 30-year fixed rate on a conforming $726,200 loan, last year’s payment was $519 less than this week’s payment of $4,538.
What I see: Locally, well-qualified borrowers can get the following fixed-rate mortgages with 1 point: A 30-year FHA at 5.99%, a 15-year conventional at 5.875%, a 30-year conventional at 5.99%, a 15-year conventional high balance at 6.325% ($726,201 to $1,089,300), a 30-year high balance conventional at 6.375% and a jumbo 30-year fixed at 6.99%.
Note: The 30-year FHA conforming loan is limited to loans of $644,000 in the Inland Empire and $726,200 in LA and Orange counties.
Eye catcher loan program of the week: A 30-year Veteran’s Affairs fixed rate at 5.25% with 2 points cost.
Jeff Lazerson is a mortgage broker. He can be reached at 949-334-2424 or email@example.com. His website is www.mortgagegrader.com.
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Jeff Lazerson - Mortgage Columnist since 2011