The Escrow Sweep Stakes
REVISED AUGUST 21, 2023 WITH CURRENT DATA
If you are like many of the settlement agents for whom we at G&A provide services, you are earning revenue that you never receive and, in most cases, do not even know about. Let’s talk about the hidden income derived from your escrow accounts.
Without getting too deep in the weeds here, simply put, U.S. banks are required to maintain a minimum dollar amount of liquidity for their immediate needs. They calculate excess liquidity or shortfalls every night after close of business. Excess liquidity, including that contributed by your escrow balances, are loaned to banks without adequate liquidity. The interest earned goes to the bank, not you. Banks that have a liquidity shortage must borrow from other banks to make up the shortage. Your escrow account balances reduce the amount your bank must borrow. The interest rate charged on these daily bank-to-bank loans is called the interbank rate. The interbank rate is based on the Fed Funds Rate.
As of August 21, 2023, the interbank rate rose to 5.64%. This is the highest interbank rate the U.S. has seen since a short period bridging 2006 to 2007. By contrast, most of the fifteen-year period since, the interbank rate has remained near zero percent.
How might this impact a settlement agent? Settlement agents who know how to take advantage of this banking practice can keep or benefit from more of the money your bank earned on your escrow balances. Settlement agents who’ve yet to realize this impact, receive no benefit. True, while the cash in your escrow account is not yours, it is not the bank’s either. Interest earned on your escrow account can either bolster the bank’s liquidity or bolster your own, where legal. Where prevented by law, an agent can nonetheless assign certain expenses to their bank, expenses directly related to maintaining that escrow account. Your expenses are ultimately paid by the bank using that interest, making focus on this a win-win for settlement agents in every state.
Let’s begin by dividing settlement agents into two groups. Some are in states that prohibit earning interest on escrow accounts, and others are not. Here are our recommendations for each.
Use Sweep Accounts in States that Permit Settlement Agents to Earn Interest on Escrow Accounts
To illustrate, here is an example. Suppose a firm maintains an average daily balance of $1M. At the current interbank rate of 5.64%, their bank makes or otherwise avoids paying interest in the amount of $56,400.00 per year. The higher the interbank rate goes, the more money a bank is making off of escrow account balances that do not belong to them.
What does your bank do with these earnings? Among other things, it gives you credit against the fees it would otherwise charge you for handling your escrow account activity. If your bank sends you a monthly analysis, you can see the amount the bank is crediting you, usually in a line item called earnings credit, along with which fees that amount covers. The earnings credit is usually a small fraction of the interbank lending interest the bank has generated. The remainder goes toward each bank’s P&L unless a savvy settlement agent does something to maximize this return.
Enter the SWEEP ACCOUNT! For several years prior to the millennium, settlement agents made millions of dollars using a simple sweep account device. Even today, companies that hold other people’s money in bulk, like payroll services, make tons of money from using sweep accounts.
A sweep account is an interest bearing, overnight investment account. The banks’ liquidity requirements are what makes the sweep account work so well. When you open a sweep account, every night, your bank will sweep the collected balance in your escrow account to the overnight investment account that’s in your name. That account earns interest at the interbank lending rate. Then, before the opening of business, the bank sweeps the investment account balance back into your escrow account. This procedure happens every business day. Over the weekend, you earn interest for two days.
That changes the example in your favor. Assume, again, that your escrow account maintains an average collected balance of $1M. In this example, you have a sweep account at your bank. At the current interbank lending rate, each day your $1M will earn interest of $154.52. That’s the $56,400.00 on the year, reconciled daily. When that $154.52 is earned on an account in your actual name, you can frequently get a better portion of the fifty-four grand in interest back.
In reality, your bank incurs costs to maintain your escrow account and those costs will be deducted from any interest you earn in the sweep account. Sweeping is neither a 100% return nor free money for the settlement agent, but it might just be an easy, steady, unexplored revenue stream that helps your firm’s bottom line. Before, the bank was utilizing your escrow’s interest to pay its own interest when borrowing and to lend out when other banks borrow, keeping the net bulk on its balance sheets and only remitting to you enough to cover fees. Now, with a sweep account, you are in that loop. Your sweep account does for you what the banks do for themselves.
Recommendation: Talk to your banker now. Remember, the interbank rate varies and, at present, it is very high. Find out what your bank can do to help you earn interest on your idle escrow account balances. Some banks offer more sophisticated sweep accounts that earn greater interest. Caution! Your sweep account must be invested in federally insured deposit accounts, meaning they should remain within the U.S. banking system. When it comes to sweep accounts, there should be no investing in Eurodollar futures, crypto, or any other seemingly attractive alternative.
Assign Expenses to your Bank in IOLTA States / States that Prohibit Earning Interest on Escrow Funds
Many states prohibit settlement agents from earning interest on their escrow account balances. States that require attorneys to maintain IOLTA (interest on lawyer’s trust account), further require that the banks remit any excess interest to the state bar for the bar’s use. But, there are still a few financial moves the savvy settlement agent can employ in states like this to maximize returns related to escrow interest.
In the great many cases where a settlement agent is also an attorney and therefore subject to the rules of the state bar, said attorneys must use IOLTA accounts for their client trust and their real estate escrow accounts. IOLTA accounts are interest bearing accounts and the bank is allowed to charge their fees against the interest earned. The net interest is then remitted to the bar or some other organization designated by the bar.
If you operate in a state that prohibits a settlement agent earning from interest on escrow accounts, whether or not the agent is an attorney, you can still maximize your own return on the escrow interest earned by assigning expenses you incur to your bank. Have your bank absorb those costs or have them directly pay an outside entity for services received in connection with your escrow account.
Examples of expenses that you may assign to your bank are:
Positive pay service fees
Escrow account reconciliation fees
Check printing fees
Remote deposit service fees
Wire transfer fees (incoming and outgoing)
Recommendation: Talk to your banker now. Explore what they are willing to do for you. Escrow accounts are coveted by banks because of the large number of dollars that flow through them and the resulting idle funds that the bank can invest for its own benefit. Chances are that, even though the bank cannot legally pay interest to you, they can cover some of your normal expenses that are directly related to the maintenance and operation of your account, all with an eye toward keeping your business.
WE CAN HELP!
For a free analysis of your escrow account and how much additional revenue is hidden within, give us a call. One of our escrow accounting experts will be happy to help you assess any benefits you’ve been missing regardless on the state in which you conduct business.