The U.S. Supreme Court was asked to rehear arguments regarding the applicability of federal preemption standards to state laws requiring banks to pay interest on mortgage escrow accounts.
The request highlighted the split among federal judges over their interpretations of the preemption standard, which has grown more evident over the course of a series of court cases in recent years.
National banks and prudential regulators have argued federal laws preempt those imposed at the state-level with respect to mortgage escrow accounts in a number of recent court cases, but the case at the center of the petition is easily the most high-profile with respect to preemption.
With these arguments in mind, the question facing the Supreme Court is the same as it was two years ago: Does the National Banking Act (NBA) preempt the application of state interest-on-escrow laws to national banks?
Revisiting Cantero v. Bank of America
In 2024, the Supreme Court granted a petition of certiorari in the case of Cantero v. Bank of America, which vacated and remanded the Second Circuit’s decision holding that the NBA preempts state laws requiring banks to pay interest on mortgage escrow. The justices found the Second Circuit’s view of the preemption standard codified in Dodd-Frank was too expansive.
On May 5, Second Circuit ruled, 2-1, that state escrow laws are preempted by the NBA, setting the stage for the high court to grapple with the question for a second time.
The cert petition – filed by Alex Cantero, Saul Hymes and Ilana Harwayne-Gidansky – formally asked the court to take up the case again, arguing the Second Circuit’s interpretation of the preemption standard would mean certain state laws – such as New York’s controversial mortgage escrow law – would be preempted “only if” it “prevents or significantly interferes with” a national banking power.
New York’s “interest-on-escrow” law states that any mortgage institution maintaining an escrow account on a one-to-six family owner-occupied residence must credit the account with interest at a rate of at least 2 percent per year. This rate must be calculated quarterly based on the average balance or set higher by the state’s superintendent of financial services, depending on which is greater. The law also restricts service charges on escrow accounts, prohibiting them unless expressly agreed to in a loan contract predating the law.
Petitioning the Supreme Court
The petition noted that, on remand, “a divided Second Circuit panel again held that New York’s interest-on-escrow law is preempted.”
“In doing so, the panel majority adopted an ‘approach that is just as capacious’ as the prior approach that this court unanimously rejected,” the petitioners wrote. “And the panel majority expressly ‘disagree[d]’ with a First Circuit case that applied this court’s decision in Cantero to ‘reach[] the opposite conclusion’ as to another state’s materially similar interest-on-escrow law.”
The financial services industry and the Office of the Comptroller of the Currency (OCC) have stood firm in asserting that such requirements interfere with their banking powers and, therefore, preempted by the NBA. In December, the OCC issued a proposed rule asserting its preemption authority over state escrow laws, which received strong support from industry trade groups.
Industry research
Research published by the Bank Policy Institute (BPI) highlighted the many uncertainties leftover after the high court’s Cantero in a working report, published in January.
Using 2018-2024 Home Mortgage Disclosure Act data in a “difference-in-difference” framework, the BPI report asserted that requiring lenders to pay interest on mortgage escrow funds does not benefit consumers.
“Our estimates suggest that lenders almost completely offset lost revenue by increasing up-front origination fees,” the report stated. “Low-income borrowers are those most affected, indicating a potential regressive cross-subsidy resulting from the regulation. We also find this rule lowers the likelihood applications are originated, again with greatest effect on low-income applicants. Unlike the results on origination fees, which constitute a surplus transfer, changes in the likelihood of origination signal total surplus declines stemming from this policy.”
The report went on to explain the trade group’s agreement with the numerous challenges against state laws requiring interest payments on escrow in recent years, on the grounds that they violate national bank preemption principles.
“The plain argument is that these accounts are a core component of bank’s lending function, and thereby significantly interfere with national banking powers. The underlying claim is that interest rate on escrow is, in effect, not different from any other interest rate set by the bank. Regulating rates set by national banks may be interpreted as significantly interfering’ with their core lending business, which under controlling Supreme Court precedent would cause the state law at issue to be preempted.”
Having a definitive answer to this question is critical to lending institutions and their borrowers as billions of dollars in interest payments are at stake across millions of mortgage accounts. It tests the boundary between federal banking authority and states' consumer protection powers.
Counterarguments from consumer advocates
Numerous consumer advocacy organizations have consistently pushed back against the argument that federal statutes should preempt state laws on interest-on-escrow.
Prior to the Second Circuit’s first Cantero ruling, the Conference of State Bank Supervisors and the American Association of Residential Mortgage Regulators filed an amicus brief, asserting that both the statutory text and the background of Congress’s enactment of the Dodd-Frank Act are indicative of Congressional intent for a more narrow form of preemption than applied by the Second Circuit.
According to Dodd-Frank: “State laws play an important role in protecting consumers against fraud, abuse, and confusion in the realm of financial services and in supporting financial stability and health. Consequently, broad approaches to [NBA] preemption of state laws … harm consumers.”
The trade associations contended, “the ramifications of the decision below would create a financial marketplace dominated by national banks and severely impair the [s]tates’ ability to protect their residents from fraudulent and abusive financial practices.”