3.2 Trust Account Management & Handling Borrower Funds

3.2 Trust Account Management & Handling Borrower Funds

Mortgage lenders, brokers, and loan originators frequently receive funds belonging to borrowers, sellers, or third-party service providers (such as appraisers and credit reporting agencies). Under California law, handling these funds creates a strict fiduciary duty. Both the Department of Financial Protection and Innovation (DFPI) and the Department of Real Estate (DRE) enforce stringent regulations governing trust account operations, impound accounts, and advance fee accounting.

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Core Rules of Trust Accounting

1. Definition of Trust Funds

Trust funds are any funds held by a licensee on behalf of another party in connection with a mortgage transaction. Common examples include:

• Earnest money deposits;
• Borrower funds collected for third-party credit reports and appraisal fees;
• Undisbursed loan proceeds;
• Tax and insurance impound payments collected from borrowers; and
• Advance origination or processing fees.

2. Prohibition Against Commingling

Commingling is the illegal practice of mixing trust funds with the licensee’s personal, corporate, or operating funds. Licensees must maintain complete physical and accounting separation between corporate operating bank accounts and client trust accounts.

• Violation: Depositing a borrower’s appraisal check directly into the company’s operational checking account constitutes illegal commingling, even if the appraisal fee is subsequently paid out of operating funds.

3. Prohibition Against Conversion

Conversion occurs when a licensee or MLO uses borrower trust funds for unauthorized purposes, such as paying office rent, payroll, or personal expenses. Conversion is a severe criminal offense (grand theft) and results in immediate license revocation.

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Trust Account Maintenance & Deposit Requirements

To ensure complete asset protection, California law specifies mandatory operational procedures for establishing and maintaining trust accounts:

                  TRUST FUND RECEIPT & DEPOSIT WORKFLOW
                                   |
        Borrower Funds Received (Check, Wire, ACH, or Cash)
                                   |
                     PROMPT DEPOSIT TIMELINE
            (Must deposit into Trust Account promptly)
                                   |
       NEUTRAL FDIC-INSURED FINANCIAL INSTITUTION (IN CA)
         - Account Title MUST contain "Trust Account" or "Escrow Account"
         - Protected from corporate creditor attachments
                                   |
               SUB-ACCOUNT LEDGER RECONCILIATION
         - Detailed record per borrower/loan transaction
         - Monthly three-way reconciliation required

Account Setup Criteria

1. FDIC-Insured Bank: The trust account must be established at a state or federally chartered financial institution located in California and insured by the FDIC.
2. Account Designation: The bank account title and checks must explicitly include the words "Trust Account" or "Escrow Account" (e.g., "Acme Mortgage Company, Inc. Trust Account"). This designation alerts creditors that funds in the account do not belong to the company.
3. Deposit Timelines: Under DRE and DFPI regulations, trust funds must be deposited into the neutral trust account, escrow, or directly to the intended third-party payee promptly (typically within three business days of receipt).

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Impound & Escrow Accounts (California Civil Code Section 2954)

An impound account (also called an escrow account) is an account maintained by a lender or mortgage servicer to collect periodic payments from a borrower for property taxes, hazard insurance premiums, and private mortgage insurance (PMI).

Statutory Restrictions on Mandatory Impounds (Civil Code § 2954)

California Civil Code Section 2954 protects single-family owner-occupied homeowners by restricting when lenders may force borrowers to establish an impound account. A lender cannot require an impound account as a condition of a residential mortgage loan secured by a 1-to-4 unit owner-occupied dwelling UNLESS one of the following statutory conditions exists:

1. High Loan-to-Value (LTV): The original principal loan amount exceeds 80% LTV (or purchase price);
2. Government-Guaranteed/Insured Loans: The loan is made, guaranteed, or insured by a state or federal agency (e.g., FHA, VA, CalVet);
3. Tax/Insurance Default: The borrower failed to pay property taxes or insurance premiums when due within the preceding two years;
4. Loan Default: The loan is in default or subject to a formal modification agreement; or
5. Express Written Request: The borrower voluntarily requests an impound account in writing.

Interest Payable on Impound Accounts (Civil Code Section 2954.8)

Under California Civil Code Section 2954.8, any lender or mortgage servicer maintaining an impound account for a single-family owner-occupied residence in California must pay interest to the borrower on funds held in the impound account:

• Minimum Rate: At least 2% simple interest per annum.
• Calculation & Credit: Interest must be calculated on the average daily balance and credited to the borrower's account or paid directly to the borrower at least annually.

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Advance Fees & DFPI / DRE Accounting Standards

An advance fee is any fee collected from a borrower prior to the actual funding and closing of the loan (excluding standard third-party charges like credit reports and appraisal fees).

Requirements for Advance Fee Collection

1. Prior Agreement Approval: Licensees operating under DRE jurisdiction must submit advance fee agreement forms to the DRE for formal approval prior to use.
2. Immediate Trust Deposit: All unearned advance fees must be deposited immediately into an FDIC-insured trust account.
3. Itemized Accounting Statements: Licensees must provide borrowers with detailed, itemized monthly accounting statements showing:
   • Total advance fees received;
   • Specific services performed;
   • Itemized disbursements made; and
   • Unearned remaining balance on deposit.
4. Unannounced Inspections: Both DFPI and DRE possess statutory authority to examine licensee trust accounts, bank statements, and reconciliations at any time without prior notice. Failure to maintain balanced trust ledgers constitutes grounds for summary suspension.