In my area real estate taxes are paid in 2 equal installments, mostly in July and September. In order to establish our escrow payment amount we take a full years worth of taxes (both installments) plus insurance and divide by 12 months. It may be the case that the first installment is paid by the seller at closing and then our borrower's initial disclosure only shows one installment of taxes being paid. With the next installment being due the following month not shown on the disclosure. Our auditors are saying that we are collecting too much in our escrow payment and we are only allowed to collect for one installment of taxes since there is not 2 installments shown on the initial disclosure. I honestly have never heard this and immediately stated that we would just be setting our borrower up for a shortage we know that we will be paying 2 tax installments each year. She said it doesn't matter and it has to be set up for the payments coming out in the next 12 months, not a 12 month period.

The language I found states "servicer may charge the borrower an amount sufficient to pay the charges respecting the mortgaged property, such as taxes and insurance, which are attributable to the period from the date such payment(s) were last paid until the initial payment date". But when I read that I technically don't get what it's saying.

She also stated "reserves collected at closing cannot exceed a two month cushion." We routinely have the initial deposit amount exceed the two month cushion.

Basically I'm looking for validation that we have been calculating the payment correct and that the reserves are not limited to the two month cushion. And if I'm wrong please point me in the right direction of that guidance. Thank you.

Your auditor is right. RESPA statute allows lenders to maintain a cushion equal to one-sixth of the total amount of items paid out of the account, or approximately two months of escrow payments. If state law or mortgage documents allow for a lesser amount, the lesser amount prevails.

The payments for the initial escrow statement can only be calculated based on what is actually due in the next 12 month period.
In instances where the seller has paid the first installment, you're actually going to be collecting half what the monthly tax escrow payment would be if the borrower would pay both installments. That's where a payment shock letter explaining the payment will go up significantly at time of first escrow analysis comes in handy.

Truffle is correct. To assist you, download our free Escrow Calculator from our website:
https://www.bankerscompliance.com/resources/ Go to "Free Downloads" and then click on "Escrow Analysis Worksheet" (6th from the top).

It takes about 30 seconds to complete and will tell you exactly how much you should have in the starting balance and well as how to complete the Closing Disclosure. Below those results are all of the mathematical steps to get to these answers. Instructions are at the bottom, if you need help.

Thanks for your help.

to add on to this; what if we have a transaction where the seller paid the second half of taxes, but we don't know what the next tax installment amount will be since this is before July. How do we calculate that amount without going over the reserve allowance?

You base all escrow calculations on the most recent bill available. When it comes to taxes, that is often last year's bill, whether it's been paid or not.

If you're in a state like ours, the new tax bill comes out literally just a couple weeks before the first payment can be made. (WI mandates giving the borrower a trio of choices for when you pay taxes to get tax write-offs.)

In your case, just follow the regular calculations (or use David's tool linked above) based off the amount the seller paid for all of last year.

I'm being told the Loan Department calculates the projected amount based on an equation of "purchase price or appraised value (whichever is less) * 1.25%". At my previous company, we used the previous tax installment amount and calculated from there.

That is not how it is done, unless this is new construction:

(7) Servicer estimates of disbursement amounts. To conduct an escrow account analysis, the servicer shall estimate the amount of escrow account items to be disbursed. If the servicer knows the charge for an escrow item in the next computation year, then the servicer shall use that amount in estimating disbursement amounts. If the charge is unknown to the servicer, the servicer may base the estimate on the preceding year's charge, or the preceding year's charge as modified by an amount not exceeding the most recent year's change in the national Consumer Price Index for all urban consumers (CPI, all items). In cases of unassessed new construction, the servicer may base an estimate on the assessment of comparable residential property in the market area.