A cure for the mortgage-servicing blues

The "fun" begins after the mortgage loan is closed. A servicing file opens when the origination file closes, and the borrower embarks on a long, and sometimes aggravating, journey with a servicing agent he didn't select.

The servicing agent is the firm that receives the mortgage payment, keeps the payment records, provides borrowers with account statements, imposes late charges when the payment is late, pursues delinquent borrowers and forecloses when they default. In many transactions, servicing agents also pay property taxes and insurance with money placed in escrow by the borrower.

From a borrower's perspective, the quality of servicing is generally very poor. My mailbox is stuffed with complaints such as these:

"My lender sold the loan and the new lender shortened the grace period and tripled the late fee ... "

"My lender hit me with a late charge when my loan was paid on the 16th instead of the 15th, and for seven months after that I have been hit with a late charge, even though all payments were made on time."

"My lender did not pay the taxes on time or for the correct amount ... "

"My lender bought insurance on my house and added the premium to the loan balance, even though I already have insurance that I pay for ... "

"My lender sends me statements that only show the payments, not the balance ... I have no idea how they are applying the payment."

The Department of Housing and Urban Development reports that two of every five complaints they receive from borrowers involve servicing issues. J.D. Powers and Associates, which measures consumer satisfaction with business services of many kinds, reports that only 10 percent of borrowers are happy with their home-mortgage servicing agent.

Why is this? The servicing agent is selected by and paid by the lender. While borrowers can choose from whom they borrow, they can't choose the servicing agent. The agent may be the lender who originated the loan but often isn't. Servicing is frequently sold. Borrowers must be notified of servicing transfers but cannot prevent them.

Nor can borrowers fire their servicing agent for poor performance. The only way they can rid themselves of a bad servicing agent is to refinance, but then they are gambling that the new agent will be better, which is a bad bet.

Since borrowers don't choose servicing agents and can't fire them, quality of service to the borrower has little to no impact on the agent's bottom line. It is no wonder that service to borrowers is so poor.

But change is in the air.

Customer-oriented loan service
New technology makes it possible to design servicing systems to meet the needs of borrowers, which can be delivered over the Internet. The borrower will be the client rather than the lender. I call these "servicing systems for borrowers" or SSBs. They will emerge soon because they will be profitable.

SSBs would not replace existing servicing systems. The firms providing the services described below would be "second-tier servicers." Borrowers would make their payments to the second-tier servicers, which would then make payments to the primary servicers.

With the payments going through its hands, the second-tier servicer has command of information on the borrower's payment history. In contrast to the primary servicer, however, the second-tier servicer will use the information to provide useful services to the borrower.

The borrower may pay a modest monthly fee for a standard package of services, including the following:

Access to payment history: The major purpose of this service is to provide peace of mind that the lender is properly crediting mortgage payments. Many borrowers, especially those who make extra payments, are extremely anxious about this.

The SSB would allow borrowers to monitor their accounts continuously, and "what-if" capacity would allow them to experiment with different future payment patterns. This would allow borrowers to actively plan the amortization process, instead of passively watching it unfold.

Access to details of adjustable-rate mortgage rate adjustments: The major purpose is to provide peace of mind that the new rate has been properly calculated. ARM borrowers worry about this. The SSB would show the details of the ARM rate adjustment, rather than just the resulting new rate, which is all they get now. Borrowers will also be able to forecast what the new rate will be months in advance so they can prepare for a possible refinancing.

Cost-reduction refinance opportunities: The purpose is to flag profitable refinance opportunities. The SSB would continually monitor the relationship between the borrower's interest rate, current market rates, and the borrower's credit as affected by his mortgage payment record. On an ARM where the rate adjustments are imminent, refinance analysis would be based on the new rate forecast at the adjustment.

Cash-raising opportunities: The purpose is to provide borrowers who request it with a tool for assessing alternative ways to raise cash. The system would already know many of the required data inputs, including the borrower's existing mortgage balance and terms, and current market terms. Other data inputs, such as the amount of cash needed, would be entered by the borrower.

PMI termination: The purpose is to give the borrower a "heads-up" that it may be possible to terminate mortgage insurance. This is a major concern to many borrowers because automatic termination under the Federal legislation passed in 1999 does not take account of extra payments to principal or house price appreciation. A borrower who wants to get rid of PMI earlier by taking those factors taken into account needs to take the initiative. The SSB would do this for the borrower, flagging a termination opportunity when it arose.

Alternative payment options: The purpose is to allow borrowers to pay biweekly, bimonthly or weekly. Borrowers may prefer one of these options because they find the schedule more convenient or because they want to build an early payoff plan around shorter payment periods.

The firms offering SSBs will be positioned to extract maximum value from them through the sale of other services that borrowers may need. If the system reveals a refinance opportunity, for example, the second-tier servicer will be much better positioned to become the new lender than the primary servicer. I am not able to reveal at this time, however, who these innovators will be.

Jack Guttentag, professor of finance emeritus at the Wharton School
of the University of Pennsylvania, wrote this article for Bankrate.com.
Comments and questions can be left at http://www.mtgprofessor.com.