In the property tax servicing industry, one of the trickiest parts of escrowing servicing is timing the payment of property taxes on behalf of a homeowner. Pay the property taxes too late, and a mortgage servicer incurs penalties and interest for late payment. Paying too early can result in unhappy borrowers who haven’t saved up enough money in their escrow account yet to pay the taxes. And very early payments can even be considered RESPA violations. So finding that sweet spot for the timing of payments is not easy.
The traditional wisdom is that if a tax is due on or before the 15th of the month, then the tax should be paid the preceding month. For example, in California, property taxes are due by Dec. 10 for the first installment and April 10 for the second installment; paying them even one day late results in a penalty of about 10%, plus a small fee that varies by county. So servicers set up their systems to ensure that the vast majority of taxes for their homeowners are paid in November. This allows them time to pay taxes for properties that fall out of the automated payment process for any reason.
For example, if the loan has an escrow shortage, there is a property identification formatting issue, etc. attached to the loan that requires the servicer to research the loan and manually put it back in for payment.
Mortgage servicers have set up a very complicated system that attempts to get taxes paid on time and allows them time to perform research on exceptions. It includes offering the highest discount available if the state gives a discount for paying early, but does not pay taxes “too early” so that funds remain in the interest-bearing account for as long as possible.
This fragile system of timing tax payments has now collided with the new tax laws introduced just before the end of 2017, which threw a wrinkle into this already delicate framework.
The new tax law places a cap on how much people can deduct from their income for federal tax payment purposes for real estate taxes and state income taxes to $10,000.
This means in a state like California, where the income tax is between 8% and 10% of a person’s annual salary, and the average real estate tax bill is nearly $5,000 a year, the total taxes paid to the state exceeds $10,000 a year for many people. So they will receive fewer deductions starting in 2018.
When the effect of the new tax bill was disclosed, it caused people to start paying taxes in 2017 that were not due until 2018, in an attempt to get the full deduction one last time. So in December 2017, tax collectors were receiving thousands of very early tax payments. Some people even paid estimated tax amounts although the actual tax bill had not yet been released.
And many of these payments are coming from homeowners with escrow accounts, where their mortgage servicer is obligated to make the tax payment, not the homeowner.
So the fragile ecosystem of tax payment timing has been disrupted, and there will be a cost for that disruption: a cost for tax collectors, mortgage servicers and many frustrated homeowners researching what is happening to their tax payments and escrow accounts.
This issue is not isolated to California. The same thing is happening in New York, New Jersey, Massachusetts, Illinois, Maryland, Virginia and any area where real estate tax amounts and income taxes are high enough that folks will not get their full deductions starting in 2018.
Take a look at New York, for example. The town and city tax bills are due between Jan. 31 and Feb. 15. So the mortgage servicing companies have set up a schedule to pay the taxes around the 15th of January. But many people paid their own tax bill in December in order to get a full deduction.
The tax collectors released the tax bill amounts to servicers in early January. And this data did not reflect those last-minute payments made by the homeowners. So the mortgage servicers will also pay the taxes, creating a duplicate payment.
The collectors will have to reconcile this information and issue refunds by the thousands. The servicers will have to research each refund and ensure the payment was truly a duplicate and the funds should be returned to the homeowner, or if an error was made in the payment process. All in all, this is a very costly research task.
The borrowers will receive refunds or notice that the servicer paid their taxes from their escrow account, and wonder why their servicer paid their tax bill since they already paid it. This will generate thousands of calls to the servicers, which will require them to spend money on staff in customer service areas to answer those questions.
For other states, such as New Jersey, the tax bill that was due Feb. 1 and paid by the homeowner in December caused many of the collectors to suppress reporting the tax amounts to the servicers until they could post all of those last-minute payments to prevent the thousands of refunds. However, this also costs them time and money to process.
This means the servicers will receive that tax data much later than normal. This will compress the payment cycle from the normal three to four weeks into a one- to two-week process, making it very difficult to process payment exception items, which require research on time to prevent penalties.
Also, many collectors in New Jersey do not issue refunds. They simply apply any overpayment amount to future tax installments. This will cause confusion for servicers and homeowners and raise many questions. Was the payment accepted? Did it get applied to the next installment, or will it be refunded? All of this will end up affecting tax collectors and servicers financially and confuse homeowners, who are just trying to get their full deduction one last time.
In a country where there are more than 20,000 taxing authorities, throwing a tax change into the mix that affects the timing of tax payments with no notification to the affected parties (tax collectors and servicers) has tremendous consequence. Several industry players will soon be dealing with and paying for those unintended consequences.
Mark Collins is senior tax executive, special projects, for LERETA.