Originating and servicing loans can provide a steady stream of income for bankers
Jim McDonald, founder and president, McDonald Computer Corp.
As published in Scotsman Guide’s Residential Edition, November 2012.
In the past 20 years, it has become increasingly unusual for mortgage bankers and lenders to service the loans that they originate. Instead, large servicers have enabled originators to sell their mortgage-servicing rights, giving them immediate income in lieu of collecting servicing fees over an extended period of time. With this arrangement, originators can focus solely on closing loans, and they don’t have to maintain a servicing department, with all its associated costs and problems.
Perhaps it goes without saying that this approach has been successful for many companies, although the relationship between originators and borrowers has taken a definite hit in the past few years. After the mortgage industry took a downward turn in 2008, delinquent loans skyrocketed, home values crashed and servicing loans became more costly as selling homes became more difficult for millions of homeowners.
The housing crisis and general economic downturn caused many mortgage bankers and lenders to feel justified in their decision to sell their servicing rights. Since the late 1980s, mortgage originators have had a generally strong market with only mild downturns along the way. Before this time, the mortgage industry was a roller coaster with ups and downs every few years. Although companies with servicing income could survive these downturns until the market improved again, companies with only origination income often disappeared.
With that in mind, mortgage professionals must ask themselves a key question: Will the origination market continue to be dynamic or is the industry poised for a deep downturn in business? To some extent, a market downturn and inflation seems inevitable. If interest rates increase dramatically, borrowers that refinanced their homes at low interest rates will not refinance for quite some time nor will they want to sell their homes and take on higher-interest loans. Borrowers have become accustomed to unbelievably low rates. If rates rise to 12 percent or more, many consumers will feel sticker shock similar to what was experienced in the early 1970s, when automobiles almost doubled in cost overnight.
How can mortgage bankers and lenders prepare themselves for such a market scenario? Arguably, now is the time to retain mortgage-servicing rights and avoid selling off the future, as doing this can help your organization brace itself for potentially rocky times ahead.
Retaining servicing rights may make more sense now than it ever has before, in that retaining these rights can act as a hedge against inflation and recession. If inflation skyrockets, originations and related business likely will suffer. Likewise, if a recession occurs, originations may crash, as well.
Servicing income, however, can provide essential revenue regardless of the business climate. As any successful company knows, surviving industry lows is critical to long-term success. Financial institutions must be as prepared for the bad times as they are for the good, and organizations without long-term plans may not survive. With the current value of mortgage servicing rights at a low point, now is an opportune time for companies to build servicing arms and retain as much servicing as they can afford.
Focus on service
Mortgage bankers and lenders also should consider the fact that retaining mortgage servicing rights makes sense from a consumer standpoint. If borrowers had a choice, would they close a loan at a local company and then approve a transfer of servicing to a company located potentially thousands of miles away? For many consumers, approving such a transfer just wouldn’t make sense.
Although this kind of choice is strictly hypothetical right now, there recently has been some sympathy to the idea of requiring borrowers’ approval to transfer servicing rights to a third party. Should related legislation ever pass, it would be a great boost to consumer protection and customer service, but would force originators to service many of the loans that they close. In this way, retaining rights now may allow organizations to get ahead of the curve.
Many within the mortgage industry would agree that customer service has taken a wrong turn in the past 20 years, but organizations today have an opportunity to fix that. With better customer service and protection acting as the focus of some new servicing legislation, retaining mortgage-servicing rights enables bankers and lenders to remain in control of the loans that they create, as well as the customer service that their borrowers receive.
This past July, the Consumer Financial Protection Bureau (CFPB) reported that 43 percent of the more than 55,000 consumer complaints received since its establishment in July 2011 were regarding mortgages. More specifically, 54 percent of those complaints focused on problems encountered trying to make loan payments and 25 percent related to loan servicing.
Although the servicing industry itself may make strides to eliminate these customer-relations issues in the future, originators already holding these relationships can take advantage of the opportunity and position themselves as the trusted organizations that borrowers depend on throughout the lifecycle of their loans. Additionally, sustaining these relationships can provide the chance to cross sell other products over the course of many years — not to mention that controlling borrower satisfaction and creating more satisfied customers can lead to stronger referrals.
Admittedly, many mortgage bankers and lenders perceive certain risks associated with retaining servicing rights, but the risk in today’s market may be less than it once was. For instance, although inaccurate underwriting has plagued the industry in the past, loans originated today are completed under some of the most stringent underwriting standards in history. This can result in a dramatically reduced default risk for lenders and the creation of loans that can stay on the books and generate revenue for years to come.
Further, mortgage bankers and lenders should consider issues of liability. For instance, if a company releases the servicing rights on a loan to a third party and the loan goes bad, who takes the hit? The third party isn’t liable; rather, the original lender is. By retaining a loan’s servicing rights, the institution that invested in the loan is more apt to work out a loan modification with the borrower than a third party would be. Organizations that retain servicing rights also are more likely to have established relationships with borrowers, which can provide at least some chance of saving the loan and leaving the borrower a happy customer.
Banks and lenders that choose to start servicing gradually or maintain only a certain amount of servicing rights can further mitigate risk by carefully analyzing each loan that’s being considered for servicing. In assessing a loan’s future revenue and cost stream, lenders can look at several areas, like the ongoing cost of servicing a particular loan type, the value of escrow balances, fees and ancillary income. This evaluation can help determine the best decisions regarding an organization’s long-term financial success.
Another challenge that bankers and lenders may see when considering servicing is the already uncertain regulatory landscape and the understanding that more change is inevitable. Servicing certain loan types can be tedious at times, and with new servicing standards coming from many directions — the CFPB, the Dodd-Frank Wall Street Reform and Consumer Protection Act and the 2012 attorneys general settlement, among others — entering the servicing business now may strike many as somewhat risky.
That said, although compliance requirements certainly should be a top priority for servicers, technology systems have greatly matured to accommodate their ever-changing needs. For instance, investing in a servicing platform that offers loan access online in real time to the servicer and the borrower can be a worthwhile investment. If buying a home is all about “location, location, location,” servicing a loan is all about “information, information, information.”
Technology investments are never easy decisions, but servicing systems available today are not only cost effective, but are designed to ease daily operations and help organizations achieve compliance and accomplish more tasks with fewer resources — especially if software providers are willing to help their customers achieve the required compliance. The revenue from servicing alone enables servicers to experience an excellent return on their investment in a relatively short period of time, making quality technology systems all the more affordable.
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Boiled down, mortgage-servicing rights are simply assets, and as such, mortgage bankers and lenders must make a choice about whether to sell those assets now or retain them for future income. By selling them now, originators forego greater future returns on investment and forfeit the chance to develop the longstanding relationships with borrowers that lead to customer satisfaction, ongoing cross-selling opportunities and valuable referrals. Retaining rights may take an upfront investment of capital, resources, time and development, but the costs are likely to be justified in the long run if one considers business continuity, borrower relationships and the image of the industry itself.
Jim McDonald is the founder and president of Southfield, Mich.-based McDonald Computer Corp., the country’s oldest privately owned mortgage-servicing software company. Web/T.I.M.E., its flagship offering, is an automated servicing platform that allows servicers to access loan information online in real time through a secure shell (SSH) virtual private network (VPN) connection. Reach McDonald at email@example.com or by calling (800) 966-8463, ext. 2916.