When my parents bought their first home in 1967, it was a VA loan at 6.5 percent. The local bank did the loan, and on the first of every month my mom would drive the check over to the bank and give it to the teller (I still have the silver dimes and quarters that the teller would save for me). Thirty years later, my parents paid the loan off.
Huh? Silver coins? Paying the same mortgage off for 30 years? What’s he going to bring up next, Yap stone money? Time isn’t the only thing that has changed since then, and now every lender and servicer talks about marketing, borrower retention, refinancing, mortgage servicing rights (MSR) valuation, and managing the servicing asset. How did it come to this, and why is servicing coveted by lenders, large and small alike?
With the invention and development of the mortgage-backed security (MBS) system, assets like mortgages could be bought and sold, even if a particular loan was not in a security backed by mortgages. These loans have two sources of value:
Not only that, but mortgages can be grouped into different pools depending on their characteristics, including servicing attributes, which can add or subtract value.
Lenders and their originators know that the mortgage servicer handles, as you can guess, the “servicing.” The MLOs typically explain to their clients that the basic servicer responsibilities include collecting and processing the monthly payments, sending out statements, handling escrow accounts, and providing customer support. More often than not, the MLOs have to explain this because a mortgage servicer is often different from the lender. Put another way, the institution that approved a borrower’s application, processed the loan, and loaned the person the funds to buy or refinance their property is often not the one to service the loan in the future.
A servicer is needed to ensure that all the correct parties are paid on time and that any issues with the borrower or the loan are handled properly. It’s likely the mortgage note will have already been sold on the secondary mortgage market to a government-backed home mortgage company, such as Fannie Mae or Freddie Mac, or to a pension fund, an insurance company, or a money manager. Or, in the case of a bank or credit union, the loan may be put into its portfolio of other assets and serviced by the bank or credit union. But, in general, independent mortgage banks, and often banks and credit unions, bundle similar mortgage types and sell them as investments.
Mortgage servicers don’t work for free, and this is the basis of the value of servicing. It is a numbers game. Basically, if the servicer is being paid $100 per month to service a given loan, and it costs them $30 in labor and other overhead, they make $70 per loan per month. If the servicer can drive down the cost, either through efficiency or servicing more loans or lowering their overhead so that it costs them $20 per month to service the loan, then they make $80 per loan per month. It’s as simple as that.
More specifically, loan servicers make money by charging fees for managing loans, which typically range from 0.25 to 0.5 percent of each payment collected. These fees are generally what the particular program pays, or the market will bear. The servicers receive these fees for services such as collecting payments, maintaining records, and managing escrow accounts.
In addition, whatever company “owns” the servicing arguably has the inside track as to if and when the borrower refinances the loan. On top of that, companies have opportunities to connect with customers in general. So yes, it is a revenue source, but far-sighted owners of the MSRs try to fully utilize these opportunities and foresee the advantages or disadvantages of owning certain types of servicing. Owners of the mortgage servicing rights need to provide value to customers, something that seems to become more important every year.
Servicing is not a cakewalk. There’s more time for problems to arise, more time for borrowers who weren’t happy with the initial loan process initially to find faults in the servicing. An institution may want to retain servicing in its banking footprint, but if this servicing is not valuable to others the book value may decline, for example. Many companies “farm” the servicing out to subservicing institutions, adept at the compliance, regulatory, and customer service nuances.
This explanation of the servicing basics, and why servicing is valuable, is intended as a primer for those in the business who aren’t exposed to this side of revenue. As originators have become more experienced and search for adding value to their customers, knowing the who, what, why, and when of mortgage loan servicing is more important than ever. And being able to explain it to a borrower adds even more value. Rob Chrisman
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