After Years of Mortgage Escrow Limbo, National Banks Will Soon Learn Their Fate
ABSTRACT: Federally chartered banks may soon be required to comply with state consumer protection laws that require banks to pay at least 2% interest on mortgage escrow accounts. The Supreme Court will decide the issue during its upcoming term in Cantero v. Bank of America.
The Second Circuit recently ruled—in favor of Bank of America—that the National Bank Act preempts state laws that require financial institutions to pay interest on mortgage escrow accounts. Currently, only 13 states have such laws, but states may decide to expand their authority if the Supreme Court rules to broaden state power over federally chartered banks.
Financial institutions in America have long been governed by the “dual banking” system. This concept traces back to the Supreme Court’s 1819 decision in McCulloh v. Maryland, where it held that Maryland’s taxation of the national bank was unconstitutional. In 1864, Congress passed the National Bank Act (“NBA”) which allowed banks to be formed under a federal or state charter and subject to federal or state law, respectively. However, after the national banking crisis in 2008-2009, Congress passed the Dodd-Frank Act which now demands national banks to comply with state consumer financial laws under certain circumstances.
As readers may know, to ensure timely payment of property taxes and insurance premiums, many mortgage lenders require borrowers to regularly deposit money into escrow accounts. Many times, these accounts have positive balances for extended periods of time. To prevent lenders from effectively receiving an interest-free loan from the customer, states have required lenders to pay a minimum interest rate on mortgage escrow accounts. These required interest payments are, in fact, consumer protection laws.
In August 2010 and May 2016 respectively, petitioner Alex Cantero and petitioners Saul Hymes and Ilana Harwayne-Gidansky obtained mortgages on New York homes from Bank of America, a federally chartered national bank. Petitioners’ mortgages required them to deposit money into escrow accounts. Relevant here, New York law provides “mortgage investment institutions” that maintain escrow accounts must pay at least two percent interest on those accounts. Contrary to state law, Bank of America paid no interest to petitioners on their escrow balances. Cantero and others filed a putative class action and the district court found in favor of the class.
Bank of America appealed to the Second Circuit, and it reversed in favor of the federally chartered bank, ruling that the NBA preempts state laws that require financial institutions to pay interest on mortgage escrow accounts. Cantero v. Bank of Am., N.A., 49 F.4th 121.
This decision created a split of authority over the issue. Just last year, a Ninth Circuit case ruled in favor of borrowers, dictating that state law controlled. Kivett v. Flagstar Bank, FSB, 2022 U.S. App. LEXIS 13347.
Issue Before the Supreme Court
The issue in Cantero is whether the National Bank Act [12 U.S.C. § 21 et seq.] preempts a New York law that imposes a 2% interest payment on escrow accounts for residential mortgage borrowers. The Second Circuit ruled that the National Bank Act preempts the New York law because the “interest on escrow account” rule significantly interferes with incidental national bank powers.
In Barnett Bank of Marion County, N. A. v. Nelson, 517 U.S. 25 (1996), the Supreme Court held that a federal statute that permits national banks to sell insurance in small towns pre-empts a state statute that forbids them to do so. A state law that prohibits national banks from engaging in conduct that the NBA expressly authorizes created an obvious and substantial practical impediment to national banks’ exercise of their powers. The Court explained that “normally Congress would not want States to forbid, or to impair significantly, the exercise of a power that Congress explicitly granted.” The Court emphasized, however, that States have “power to regulation national banks, where doing so would not prevent or significantly interfere with the national bank’s exercise of its power.”
After Barnett Bank, Congress clarified the standard for NBA preemption of state consumer financial laws, through the Dodd-Frank Act. As relevant here, the National Bank Act says that a state consumer financial law is preempted only if:
(A) application of a State consumer financial law would have a discriminatory effect on national banks, in comparison with the effect of the law on a bank chartered by that State;
(B) in accordance with the legal standard for preemption in the decision of [this Court] in [Barnett Bank], the State consumer financial law prevents or significantly interferes with the exercise by the national bank of its powers. . .; or
(C) the State consumer financial law is preempted by [other applicable federal law].
The Court will ultimately have to decide how to interpret the “prevents or significantly interferes with” standard and how its 1996 decision in Barnett Bank should be applied to this case and future state law preemption cases.
ConclusionCantero will provide federally charted banks with clarity. If decided in favor of borrowers, Cantero will demand federally chartered banks to pay interest on mortgage escrow accounts, if applicable state law so requires. To date, Kansas, Missouri, Illinois, and Arkansas have no such laws. However, it will be interesting to see if state legislators decide to broaden consumer protection laws in light of a potentially favorable Supreme Court decision.