Background

A mortgage servicer provides the ongoing management and upkeep of a mortgage loan. The servicer's tasks include collecting principal and interest payments from the borrower and sending these amounts to the investors, collecting and distributing escrow payments for insurance and property taxes, advancing payment to investors on behalf of delinquent borrowers, working with borrowers to modify mortgage terms, and, in the case of borrower default, pursuing liquidation options, including foreclosure or short sale.

Servicing is performed by banking institutions, credit unions, and nonbanks. Nonbanks refer to financial institutions that do not have a depository institution within their overall operating structure.

While servicing is inherent in all mortgage loans, an MSR is created only when the act of servicing is contractually separated from the underlying loan. An MSA therefore is created when a firm retains the right to service a loan that it sells to a third party, such as an issuer of mortgage-backed securities (MBS), and certain other conditions are met.¹⁰ From that point forward, the MSA is considered a separate asset from the underlying mortgage loan, and the servicing rights can be retained by the loan originator or transferred to another firm (subject to the consent of the owner of the underlying mortgages).¹¹ An MSA is not created when a firm services a loan that the firm originates and holds for long-term investment.

There are several reasons why a firm may choose to sell a mortgage loan while retaining the servicing rights. The primary reasons to sell a mortgage loan include generating capital that the firm can use to make additional investments, including new mortgage loans, and managing interest rate risk. By retaining the servicing rights, the firm maintains its relationship with the borrower, thereby allowing the firm to cross-sell products to the borrower and to earn a servicing fee.

A servicer's primary source of revenue for this activity is the servicing fee. The servicing fee is generally a fixed percentage of the unpaid principal balance (UPB) of the underlying mortgage loan. The servicer may also receive ancillary fees (e.g., late fees and loan modification fees) and interest (or "float") earned on principal and interest and taxes and insurance collected and held by the servicer before distribution. The servicing fees, ancillary fees, and float typically exceed the cost of servicing the loans, resulting in a profit for the servicer.

Servicers may incur a variety of expenses in the process of servicing loans. These expenses include the basic costs to operate a business, including employee salaries and benefits, premises costs, and technology costs. Nonperforming loans contribute significantly to a servicer's costs and can reduce profitability. For a mortgage that is delinquent or has defaulted, a servicer will need to employ additional staff to perform collection activities, loss mitigation activities, or to manage the foreclosure process. A servicer also may be required to advance payments to the investors, insurers, and taxing authorities, and may be required to pay third-party fees related to foreclosure proceedings. In addition, a servicer will incur costs related to unreimbursed foreclosure costs and real-estate owned losses.¹²

The majority of mortgage loans originated in the United States ultimately are sold in the secondary market and packaged into securities guaranteed by the GSEs or by Ginnie Mae.¹³ The GSEs may also hold in their portfolios the loans that they have purchased. The remaining loans are either held for investment by the originating firm or sold to the secondary market and packaged into private-label MBS. The GSEs and Ginnie Mae do not service mortgages directly. This fact creates a need for a robust third-party servicing industry.

Various federal and state rules and regulations address regulatory capital requirements for firms holding MSAs and mortgage servicing standards generally. In addition, the GSEs and Ginnie Mae require servicers to comply with guidelines to service loans guaranteed by these entities, while separate contractual provisions govern the servicing of loans in private-label MBS or for other firms.

References

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