How Subprime Woes Can Affect You, Too

In early September, homeowners in Maryland and Washington State discovered that their property-tax payments were past due. How could that be? They'd dutifully made their monthly mortgage payments, which included escrow funds to cover property taxes and homeowners insurance premiums.

Their mortgage servicer had always made the payments before. Now it appeared that they were not only liable for the taxes due, but also for any late fees and penalties.

These homeowners had one thing in common: Their mortgage servicer was American Home Mortgage, which declared bankruptcy in early August -- partly because of fallout from the subprime mortgage mess.

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When news of the missed tax payments hit the blogosphere, conjecture raged that AHM had misused the funds to cover its obligations or that its creditors had somehow seized the escrow accounts as assets. The reality is more benign, albeit with a few important lessons for homeowners.

Subprime standoff

It turns out the homeowners were caught in a standoff between AHM and mortgage giant Freddie Mac, which buys loans from smaller lenders and had contracted with AHM to service some 4,500 of its loans.

When Freddie Mac learned of AHM's impending bankruptcy, it seized $7 million in escrowed funds and demanded that AHM return the related loan files so Freddie Mac could transfer the loans to another servicer. But AHM refused, hoping to sell its loan-servicing business, and issued checks against the escrow accounts. Result: the property tax checks bounced.

The matter was settled in court on September 20. A judge ruled AHM can sell its servicing portfolio (probably by mid October) but must transfer all of its loan files to Bank of America, which will serve as an interim servicer. Meanwhile, Freddie Mac transferred $2.4 million back to AHM so that it can bring outstanding tax and insurance payments up to date.

The agreement doesn't address the issue of who is liable for any late fees or penalties, but it's likely that the tax bills will be paid before those were incurred. If not, borrowers might make a good case that their county or other taxing authority should forgive the penalty.

"Bankruptcy courts are very good at protecting the interests of borrowers and making sure that escrow funds are disbursed appropriately," says Laurie Maggiano, a spokeswoman at the Department of Housing and Urban Development.

How to protect yourself

Even if you're not aware of legal difficulties with your mortgage servicer,there are some other lessons all homeowners paying into escrow mortgage accounts should learn.

Always make your mortgage payment on time. That will help you protect your credit record and make it clear that you're holding up your end of the bargain, helping to preserve your rights, says Steven C. Sherman, a financial legal examiner for the Washington State Department of Financial Institutions.

If there's any question about your homeowners insurance premium payment being made on time, you may want to pay it yourself. Otherwise, your mortgage company might require you to buy so-called "forced place" insurance to protect the lender.

Take note of when tax and insurance bills are due and look for confirmation of payment on your mortgage statement. When you receive your annual escrow account analysis, if something doesn't seem right, call your lender or servicer, the property tax office or your insurance company.

Know who owns your loan. If you don't know, find out. Banks and brokers routinely sell their mortgages to Freddie Mac, Fannie Mae or Ginnie Mae (FHA and VA loans). "Their rules will apply when something goes wrong," says Maggiano. "In this case, if it had been Freddie Mac, you could have called and received reassurance that they would get a resolution soon, so you wouldn't have had to panic," she says.

If you're getting the run-around, call your state's agency that regulates mortgage lenders and servicers (often the state banking commission or the department of financial institutions). For more information, see "Mortgage Servicing: Making sure Your Payments Count."