States Sue OCC Over Rules Blocking Mortgage Escrow Interest Laws

Ten states have sued the Office of the Comptroller of the Currency over new federal rules that would prevent them from enforcing laws requiring national banks to pay homeowners interest on money held in mortgage escrow accounts.

The lawsuit, filed Aug. 11 in the U.S. District Court for the District of Oregon, challenges two OCC rules that took effect June 18. The states argue the federal banking regulator exceeded the authority Congress gave it when it declared their escrow interest requirements preempted and gave national banks broad discretion over whether to compensate borrowers for money held in those accounts.

Oregon brought the case with New York, California, Connecticut, Maine, Maryland, Massachusetts, Minnesota, Rhode Island and Vermont. The OCC's decision reaches beyond the states involved in the lawsuit and covers similar laws in 14 jurisdictions, including Guam, Utah, Wisconsin and the U.S. Virgin Islands.

Mortgage escrow accounts allow lenders to collect money for expenses such as property taxes and homeowners insurance as part of a borrower's monthly mortgage payment. Because those bills may come due only once or twice a year, lenders can hold significant balances for months before making the payments. Several states require lenders to pay borrowers interest while holding that money, although the rates and other requirements vary.

The OCC says national banks and federal savings associations should have flexibility to decide the terms of their escrow accounts, including whether interest or other compensation is paid and whether related fees are charged. The agency has argued that differing state requirements can increase costs, restrict banks' business decisions, and potentially result in higher fees or less mortgage lending.

Its May actions addressed the issue through two rules. The Escrow Powers Rule states that national banks have federal authority to establish and manage escrow accounts, including deciding whether customers receive interest. The Preemption Rule then concluded that New York's escrow interest requirement interferes with that authority and that laws in 13 other jurisdictions are sufficiently similar to be preempted as well.

At the center of the states' challenge is how those rules work together. Their complaint claims the OCC used the first regulation to define a broad federal banking power and then relied on that power when deciding that state requirements conflict with federal law. State officials argue Congress did not authorize the agency to create a banking power through regulation for the purpose of displacing state consumer finance laws.

Federal mortgage law already places limits on how lenders handle escrow accounts. The Real Estate Settlement Procedures Act restricts how much money lenders may require borrowers to deposit and requires disclosures about how the funds are managed, but it does not generally require interest to be paid. The states also point to later federal mortgage provisions that expressly refer to interest being paid when required by applicable state or federal law, arguing Congress expected state escrow requirements to continue operating unless they were legally preempted.

Preemption determines when federal law takes priority over state law. National banks operate under federal charters, but they remain subject to many state consumer financial laws. Dodd-Frank limits when those protections can be displaced, allowing preemption under the National Bank Act when, among other grounds, a state law prevents or significantly interferes with a national bank's exercise of its federal powers.

The Supreme Court addressed that standard in 2024 in Cantero v. Bank of America, a case involving New York's escrow interest law. The Court said the analysis must consider the nature and degree of the interference caused by the particular state requirement rather than rely on a broad rule that could sweep aside most state laws regulating national banks. The states argue the OCC instead focused on whether escrow requirements reduce a bank's flexibility to set account terms.

The lawsuit also challenges the OCC's decision to treat the different state laws as substantially equivalent. Dodd-Frank generally requires the agency to review state consumer financial laws individually before preempting them unless another law has substantially equivalent terms.

According to the complaint, the OCC analyzed New York's requirement and then grouped 13 other jurisdictions with it despite differences in how their laws operate. Oregon ties its required rate to a Treasury-based measure, while Massachusetts allows lenders to determine the rate themselves. Other laws impose fixed rates, restrict maintenance fees or apply only to particular mortgages. The states argue those differences required closer review before the OCC could treat the laws alike.

Evidence supporting the agency's decision is another point of dispute. The OCC has said state interest requirements may raise costs, prompt banks to impose other fees or reduce mortgage lending. The states counter that the agency did not rely on technical studies or other data showing that the laws significantly interfere with national banks, even though Dodd-Frank requires preemption findings to be supported by substantial evidence in the rulemaking record.

Those arguments form the basis of the states' claims under the Administrative Procedure Act, the federal law that governs judicial review of agency actions. Agencies must stay within the authority Congress gave them and provide a reasoned basis for their decisions. Courts can set aside rules that exceed statutory limits or are arbitrary and capricious because the agency failed to adequately consider the facts or explain its reasoning.

The complaint alleges the OCC violated both standards. The states argue the agency went beyond Dodd-Frank's limits on preemption and did not provide enough evidence or analysis to support its decision to displace the escrow interest laws.

They are asking the federal court in Oregon to declare the Escrow Powers Rule and Preemption Rule unlawful and set them aside.